Impact Risk in VC

This is the fourth blog post in a collaborative series between early-stage climate and sustainability VC Amasia and Malk Partners, preeminent advisors to private market investors on impact and ESG.

Introduction

Despite operating as a single bottom-line investor, impact is embedded in Amasia’s investment thesis, and Amasia closely tracks the climate and sustainability impact of its portfolio companies. For early-stage impact companies, impact may evolve with business growth, or the company may have yet to establish the appropriate processes and controls to mitigate impact risk. Thus, managing impact risk is critical to maximize impact potential, avoid impact washing, and align with industry standards. 

Amasia collaborates with Malk Partners to identify unique impact risks and value creation opportunities  with each portfolio company and supports the portfolio company to bolster its impact during the holding period.  Malk Partners advises impact investors by reviewing for potential impact risks and opportunities during due diligence, screens, monitoring, and value creation engagements with the goal to enhance impact as portfolio companies’ scale. 

What is impact risk?

"Impact risk" is one of the 5 Dimensions of Impact outlined by the Impact Management Project (IMP). The IMP defines impact risk as the likelihood the impact of an investment will differ from what was expected. Evaluating risk to impact during diligence is becoming increasingly important in the impact investing industry as it allows investors to implement tailored controls that will subsequently maximize impact potential, prevent the dilution of positive outcomes, avoid impact washing, and support alignment with robust industry impact risk management standards. Amasia leverages its impact screen during the sourcing of investments, which was developed with Malk, and based on the IMP framework to identify impact risks. 

The IMP defines 9 types of impact risk:

Fig. 1: Types of impact risk. Source: Impact Frontiers

Impact risk in VC

For early-stage impact companies, impact risks, such as evidence risk, drop-off risk, and execution risk are more common. While later-stage impact companies also experience these risks, more mature impact businesses additionally face higher exposure to alignment and efficiency risks. Outlined below are the most material impact risks for Amasia’s investments and early-stage impact VC more broadly. 

1. Evidence risk: Is there enough data to understand impact?

Tracking impact data should be a priority for impact portfolio companies to help prove positive outcomes, prepare for exit, and secure capital during fundraising. However, early-stage companies often have limited data collection and analysis capabilities, minimal data collected to date, or low-quality data, necessitating additional support from their investors to identify the correct data to track and establish the appropriate data tracking methodologies.

To minimize evidence risk, investors can collaborate with portfolio companies to build the appropriate data tracking and analysis capabilities. Even without custom tools or frameworks, investors can tap into existing industry resources to identify metrics to track and provide evidence of a portfolio company’s underlying positive impact. For example, the GIIN’s IRIS+ platform, in alignment with the IMP’s 5 Dimensions of Impact, provides useful guidance on baseline impact KPIs to track that are organized by SDG alignment or impact goals. Investors may also leverage third party expertise to minimize evidence risk – for instance, Malk collaborates with portfolio companies to collect the appropriate impact data before Amasia finalizes its investment decision. 

Amasia evaluates evidence risk as follows:

• Setting key metrics: Amasia collaborates with its portfolio companies to establish impact metrics that are feasible to track and reflective of companies' unique impact value propositions. For example, TreeDots tracks the amount of food waste it diverts from landfills to demonstrate its ability to reduce GHG emissions from food waste.

• Valuing qualitative data: Aside from relying on quantitative data, Amasia also considers qualitative data to support a company’s impact narrative or theory of change. Clarity gathers qualitative data through user interviews, exploring how their air quality monitoring devices influence decision-making, allowing Clarity to understand how the products drive real-world behavior change to address regional challenges associated with air pollution.

• Making conservative estimates: Amasia is realistic and transparent about the data limitations that portfolio companies face, and discloses these limitations to limited partners.

• Leveraging external research: Amasia uses external research to substantiate portfolio companies’ impact claims, particularly when companies are still building data-tracking processes. Leveraging external research to explain how a product or service may result in social or environmental impact is a common practice for early-stage companies.

2. Drop-off risk: Will your impact last?

Drop-off risk occurs when the positive impact does not last as long as expected. Early-stage businesses that aim for large-scale behavior change may experience drop-off risk as it takes time to scale positive outputs, and impact may be affected by a confluence of factors. Such risk which may occur if consumers stop using a company’s product, a company’s product changes, or from external factors (e.g., regulations).  

To manage this, Amasia reviews whether intentionality is embedded in the business model during the impact screening process; Malk Partners reviews intentionality and risk to impact during impact due diligence and provides corresponding recommendations in due diligence reports. Amasia shares such reports with founders to strengthen their understanding of business impact and risks and works with founders to ensure impact goals remain front and center with business growth and changes.

3. Execution risk: Can you deliver what you promise?

Execution risk arises when a startup is unable to overcome scientific, technical or business-related challenges that indirectly or directly hinder the impact proposition. Execution risk is heightened for startups due to their experimental nature, challenges with fundraising, insufficient resources, and variable annual revenue. Amasia reviews execution risk for any early-stage investment and considers whether a startup is equipped to overcome such challenges. Amasia's portfolio companies take proactive steps to mitigate execution risks by:

• Leveraging expertise: tap into strategic advice and network connections to help drive the success of the early-stage business

• Setting realistic goals:establish practical performance expectations and plan for downside scenarios with corrective actions.

• Testing and learning: deepen familiarity with market demands and customer segments by piloting new products and strategies before a full-scale launch. For example, before officially launching its food waste analytics product, StreamLine, Topanga partnered with campus customers to build and test alpha units of the product.

4. Unexpected impact risk: What surprises might come up?

Unexpected impact risk is an important factor to consider for early-stage companies, where uncertainties are high despite thorough planning. For instance, Amasia’s portfolio companies positioned in the food industry are affected by fluctuations in global food prices that are sometimes difficult to foresee – avian flu outbreaks, wars and increasingly erratic weather affecting harvests are a few contributing factors. Amasia works with them to build resilience in the face of these unexpected risks. Based on the listed examples, a portfolio company’s impact additionality, scale, or depth may become constrained, which may overall limit its intended impact.

Amasia tackles unexpected impact risk by serving as a proactive partner to portfolio companies by conducting regular check-ins to identify and address potential issues before risks escalate. 

Conclusion: keeping impact at the core

While Amasia understands the constraints that early-stage companies face, we strive to support portfolio companies’ ability to measure and manage impact. Amasia’s partnership with portfolio companies is designed to establish and scale the right strategies that maximize positive outcomes and effectively navigate impact risk.

Written in collaboration with