Do impact venture capital funds outperform traditional VC?
Yes. No. Maybe. Oh, you were hoping for a single answer? Read on.
First off, what is the crux of the question?
What we are after here is understanding the delta, if any, between financial returns of traditional venture capital (VC) and impact VC – the latter being funds with an explicit mandate to achieve market rate returns alongside positive, measurable social or environmental impact.
Why is this important?
The private markets – which include venture capital – are seen as one of the areas where an investor can achieve “deep impact” (that which is greater or more pronounced), relative to other asset classes. Beyond sustainable investing and ESG investing in the public markets, private markets have the promise of directly funding solutions that contribute to social and/or environmental impact. And while venture capital has existed for decades, a great deal of the impact venture capital funds have been formed in the last 5-10 years and trends point to increased new fund formation and follow-on funds from the incumbents.
All to say, it is critical for the continued growth of a very important part of the impact investing arena that the question of financial performance is addressed. Especially for those investors yet to deploy capital to impact strategies, who are much more likely to seek market rate financial performance than “first mover LPs”, they need to know: Will impact VC result in concessionary returns?
A few of the normal caveats apply here: Not all impact investing is intended to meet market-rate returns, and returns – especially for current impact investors – are not the only thing that matters. Even impact fund general partners score achieving financial returns low on the list of their concerns, according to the Global Impact Investing Network. Additionally, all VC/PE as an asset class, may not meet risk/reward performance compared to other asset classes.
Ok, I’m with you… but do impact VCs make money?
Using the GIIN’s Impact Investor Survey 2020, the best proxy for VC performance is embedded in private equity performance figures, which show 16% and 18% annual gross return figures for developed and emerging markets, respectively. Sounds pretty snappy, huh?
Well, maybe not.
Using the latest Cambridge Associates (CA) data from 2020, median net internal rate of return for impact VC/ PE funds is 6%, with an upper quartile figure of 11%, and a bottom quartile of 1%. This covers fund vintage years from 1998 to 2018. Digging in a bit, the median return for developed markets is 8% and 5% for emerging markets.
Fund size analysis shows that funds less than $100 million have a median return of 6%; those larger than $100 million return 7%. Contextualizing these numbers (even the high ranges): Ouch! Pitchbook data shows net median IRR figures for traditional VC ranging from 10% to 21% between vintage years 2008 and 2018; traditional VC is commonly seen as achieving at least 15% average annual returns, often higher than 20%. CA’s Venture Capital Index (not exclusively impact, and also not inclusive of PE) shows an annual net return of 25% over a 20 year period.
You had a feeling we were going here, right?
Back to the GIIN data for a moment. Keep in mind, there is quite a range with 16% and 18% as the averages for developed and emerging markets. The range for developed markets is a 25% return at the 85% percentile, down to 8% return at the 15% percentile of performance. For emerging markets the range is even larger: 29% return at the 85% percentile, and 7% return at the 15% percentile.
Anyone paying attention (or still awake) might ask a fair question: Why is the GIIN data (~17%) and CA data (~6%) so different? For one thing, CA historically had strict criteria on which funds to include in its data. Interesting to note: CA no longer publishes the Impact Benchmark, believing that comparing impact funds to others in the same vertical (i.e. healthcare) is more relevant than to a strict set of other impact funds. Secondly, perhaps there is a reporting bias in the GIIN data – only high performing (or those funds still in existence) reported back data.
So now what?
Both of the following statements are true: “Reading the data thus far, PE/ VC Impact funds can perform at market rate to traditional funds” and “For both impact and traditional PE/VC fund performance, the ranges for returns are quite large and thus achieving market rate returns is highly dependent on choosing the right managers.”
Is it more difficult to choose the right impact fund manager than traditional VC/ PE fund manager? Likely, for two key reasons. First, the universe of impact funds is quite small (CA data covers roughly 70) relative to the total universe of VC/ PE funds (1,900); there are roughly 27 times more traditional funds. Ok, so we have a much smaller “haystack”… do we have a smaller “needle” too? Yes, the range of returns for impact funds is larger than for traditional funds. Additionally, many of the impact fund managers are first time fund managers, and while past performance is no guarantee of future performance, it is something that LPs of all stripes weigh very heavily when evaluating funds (although it should be noted that some research points to first time fund managers outperforming their peers).
On one hand, if as the reader you are left with the sense that making money via impact VC is difficult, perhaps that is intuitive. After all, impact VC is a small and still developing segment of an asset class that has historically provided wide ranges of returns. On the other hand, many impact investors are quick to point out that even traditional VCs often don’t make money (that is to say, as an asset class, the additional risk and the illiquidity isn’t adequately met with improved return expectations), and that the goals of impact investors are broader than simply a pure financial return.
In summary, can you make money in impact VC? Yes, no, and maybe.
And while that may be sufficient for the current set of LPs that invest in impact funds, conventional asset owners, whose capital is critical for the continued scaling of this important asset class, will require more certainty on this fundamental question.
The author would like to thank Matt Bannick, Lauren Booker Allen and the Jordan Park impact team, Charles Ewald, and Julien Gafarou and Dario Parziale of Toniic for their feedback and recommended research for this article.
Scott Saslow is founder and CEO of One World Training and Investments.