Impact investing in 2023: doom and gloom or silver linings?

It is certainly not an easy time for social ventures and their investors. Just out of the Covid-19 crisis, many have been caught off guard by the war in Ukraine and its now well-known implications for people, the planet and the economy. Cash is again king for many social entrepreneurs, who, just a few months ago, had ambitious growth plans. Now, they need to pivot their business models and focus on getting profitable – again. Not to mention new fundraising rounds and company valuations: the trend is really gloomy these days.

Meanwhile, most impact investors do what they always do when crisis strikes: they become more risk-averse, revise their investment criteria, and focus on keeping their existing portfolio companies alive and kicking. There is a clear shortage of patient capital in the market, as recently confirmed in the case of Germany by a new market study by the Bundesinitiative Impact Investing. Thus, the phenomenon that 85% of global impact investors seek at least (close to) market-rate returns seems to be an ongoing trend, and universally valid – even more so in times of recession.

The VC space doesn’t suffer from long Covid

Yet not everything looks as gloomy at a second glance. Luckily, “the VC space doesn’t suffer from long Covid”, as Antonia Botsari (pictured), a member of the research and market analysis team of the European Investment Fund (EIF), put it in the FASE investor hangout. Botsari co-authored a working paper based on the EIF VC Survey 2022 that investigates the market sentiment and impact of the current geopolitical and macroeconomic environment. The findings are sobering, but also offer room for optimism: while the fundraising climate is at a historic low and the respondents felt the worst was yet to come, the survey also found that decreasing valuations offer more reasonable terms for investors to engage and thus a welcome market correction. Also, certain themes such as climate tech, circular economy, and agritech have become more important in investors’ agendas. On top of this, support from the public sector can have a fundamental effect on the resilience and ability of the VC and impact spaces to absorb shocks.

Reality bites but cautious optimism rules

Christin ter Braak-Forstinger (pictured), co-founder and CEO of Chi Impact Capital, who manages an impact fund out of Switzerland, can relate to the gloomier working paper findings. However, she is convinced that impact VCs have an important role to play in the current market: “They can tap into a big potential and reinvent solutions from scratch. Especially with early-stage social ventures, there is a lot of additionality to be achieved,” she said, referring to impact as well as financial value add.  She also observes that investors are building more diverse and robust portfolios across all asset classes that include catalytic products, direct investments, and a mix of impact-first and finance-first impact investments. This is supported by a high-quality deal flow: “There is a strong increase in pioneering impact companies with both positive impact creation and strong financial growth going hand-in-hand,” she said.

In the impact-first space, family offices, foundations and multilateral organisations are here to stay and less prone to the flight-to-safety syndrome

While there is no doubt that the current market corrections are painful, the effects seem to be most severe for scale-up and later-stage impact ventures. For now, very early-stage valuations might be less exposed to the macroeconomic environment, as pointed out by investment analyst Saurabh Kumar from Katapult VC. “We got a relatively more attractive entry price in slightly more mature startups,” he said. Whether or not this holds true for other investors is unclear, as data is limited and other factors may influence future valuation trends. One aspect was clear, though: VC-type, hyper-growth plans don’t have much chance of flying right now. A recurring sentiment in the room was that a long-term perspective with a focus on stable, reasonable growth is the way to go forward.

Another important aspect to consider is the difference between certain investor types: “In the impact-first space, family offices, foundations and multilateral organisations are here to stay and less prone to the flight-to-safety syndrome,” summarised Harry Davies (pictured), principal at London-based family office Ceniarth. “This is because impact is their primary mandate.” Yet he also expressed concerns that the gap between impact-first and finance-first impact investing could widen. “There is a strong risk that the senior part in blended finance structures will become more risk-averse and demand even higher returns,” he said.

Maximise impact, not growth

In addition to the sentiments described above, the lively discussion raised further insights, for impact investors and impact ventures alike:

• As a venture, it is wise to have a solid Plan B fleshed out and to adopt a 'one-profitable-product-is-enough' focus for the foreseeable future.
• Social entrepreneurs have to start really early if they need to raise capital in the current market. Also, they should try to find investors with a long-term perspective, and ideally stay in continuous fundraising mode.
• While impact VCs are clearly affected by the crisis, they are likely to face a less volatile environment than traditional VCs. In addition, specific impact sectors seem to be unusually stable, especially in the early-stage realm. Business-to-consumer solutions, however, are anticipated to be much more volatile and hit hard, in terms of both valuation and fundraising. 
• What isn’t a must-have, must be cut: this piece of wisdom refers to impact products, services and innovations as well as to growth trajectories. Essential impact solutions that address the most pressing problems, for example in climate change mitigation, are expected to find it easier to raise capital. And growth at all costs is a trap once realism rules. Investors will become more prudent and tranche their tickets, in other words provide their capital in milestone-based chunks.

Yet the crisis will also offer opportunities to re-think business models, become hyper-creative and pivot successfully. As Melody Lang, founding partner at MPA Education, summarised: “I tend to be optimistic. In the impact space you are less susceptible to crisis, especially when investing in companies that are profitable and stable”. The motto of impact investors appears to be: go for maximum impact, not for maximum growth.

Christina Moehrle is a freelance communications advisor, author, and creator of education programmes in impact and blended finance. She works with FASE among other clients.

Header image by wirestock on Freepik

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