The heightened focus on ESG has sparked the growth of impact venture funds, providing a fresh capital avenue for social enterprises.

Usually managed by large organizations and nonprofits, they differ from standard VCs in numerous ways, optimizing for social and environmental goals as well as financial returns chief among them.

However, navigating venture is challenging, a reality that’s dawning on many impact venture funds.

According to Cambridge Associates, over the 21 years to 2020, the typical impact venture fund generated a return of 10.22%, a little better than the S&P500, but with a lot more risk and a lot less liquidity.

It gets worse.

Bottom quartile funds returned just 2.43%.

Venture is hard.

And that’s because most startups are bound to fail — no matter how good their idea, business model, product, or team is.

In fact, according to the US Bureau of Labor Statistics, 90% of startups fail.

75% of startups, lucky or good enough to raise seed capital, don’t get to Series A.

And in the growth stages, only 25% of Series G companies successfully exit — Series G typically being the final round of venture funding and usually in the hundreds of millions of dollars.

These failure rates come with the territory of boldly going where no man or woman has gone before, of sailing unknown seas, and ultimately building in the face of uncertainty — where more can go wrong than right.

Startups fail because they take insurmountable risks.

While most are likely to fail, it’s a high-risk high-reward game with winners generating 100 or even 1,000X returns — something no other asset class can claim to do over comparable time periods.

Even at Y-Combinator, heralded as the pre-eminent startup incubator that spawned Airbnb, Dropbox, Stripe, Instacart, Reddit, and Twitch, only 4.5% of their 4,000 strong alumni have become billion dollar unicorns — that’s less than one in twenty.

Essentially, venture is a power law game, where a tiny percentage of companies generate the lion’s share of returns.

This is precisely why VCs typically track and review thousands of startups each year, meet with hundreds, and invest in a small handful (usually five to twenty a year depending on their model).

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What Funds Need to Succeed

Despite what some people evidently seem to think the VC game isn’t as easy as throwing money against the wall and hoping that something sticks.

At its core, to have the best chance of success in venture, you need to be able to most, if not all of the following, effectively:

1. Generate and get access to quality deal-flow
2. Effectively evaluate and pick high-potential startups
3. Leverage your resources to help them grow
4. Help them get to an exit event

To do this well requires:

• Networks
• Knowledge
• Experience
• Brand and Reputation

And even with all of this in place, you’re still likely to back the wrong horse 75% of the time.

Reflecting on this, it’s little wonder that most impact venture funds are under performing.

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Why Impact Venture Funds Are Flagging

Having randomly selected and reviewed 20 impact venture funds, most fell victim to one or more of the following pitfalls.

Lack of experience, networks, and knowledge

While most partners at standard venture funds usually come with the pedigree of having worked their way up over a decade in venture or startups, many impact venture funds seem to pluck their fund managers out of the obscurity of unrelated back office roles.

Impact venture funds are not plugged in to the global startup and venture ecosystem in the way they need to be to get visibility of deals, cast a wide net, and back winners.

Sometimes impact venture funds might find it difficult to attract top talent to run their funds if they don’t incentivize them accordingly. If managers aren’t being rewarded with carry (a piece of the fund profit and in this case, an evaluation of startup impact) and decent salaries, then the very best operators — except for the truly selfless few — are going to go to standard venture funds because that’s where they can make the most money.

Lack of brand and reputation

The best founders are like the best romantic prospects — they are in demand, know their worth, and need to be chased and sold your worth to.

To do this effectively, successful venture funds have established brands and reputations based on not only their track record and founder hearsay, but also their presence in the market.

They market themselves through social media, events, podcasts, and so on in a way that most impact venture funds simply do not.

Lack of resources

As indicated previously, the best venture funds will review thousands of startups a year and invest in only a handful.

This is a full-time job, and oftentimes requires a cast of associates and senior associates working around the clock.

Many impact venture funds are run by not only a small crew of people, but people who don’t know how to effectively evaluate a future-looking opportunity that might not become something for 5–10 years from now.

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What Impact Venture Funds Should Do More Of

1. Hire people with experience, networks, and knowledge to generate and pick winners
2. Augment internal talent with external expertise and service providers
3. Make brand, PR and marketing core to their operations
4. Focus on building relationships with aligned angels and VCs in target sectors and geographies
5. Better understand and define how they can use their organization’s resources to help startups grow, without subjecting said startups to debilitating bureaucracy

If impact venture funds are going to not only generate financial returns, but bring to life companies making a real environmental and social impact, then they should take the art of venture investing more seriously and deploy the talent and resources required.

Anything short of this is downright reckless and irresponsible.

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