By Emily Maria Goehlmann, Kathleen Lameter & Prof. Kristjan Jespersen
Startups such as Airbnb and Spotify shaped our society in multiple ways – from how we book and rent out flats to how we access our favorite music. Their disruptive power is a typical characteristic of a venture case. The disruption caused by such firms can be used for sustainable development, too. The movement from unicorns to zebras is increasingly acknowledged by investors on a global scale – a movement in which Venture Capital (VC) plays an important role.
Currently, VC focuses almost exclusively on profitability and financials. The study underlying this post found that sustainability plays – if even – a minor role in investment decision-making. However, Venture Capitalists (VCs) are increasingly pressured by society, regulators, and their limited partners to implement sustainability and ESG (Environmental, Social, and Governance issues) into their investment processes. Thus, one can see a paradoxical situation as sustainable New Ventures (NVs) are facing challenges in raising money, while investors are supposedly increasingly looking into placing sustainability cases in their portfolios.
But why are sustainability and ESG not implemented more into VC investment decisions? The theme of sustainability and ESG in VC and NVs is a field of great uncertainty. Through interviewing multiple VCs, founders of NVs, and specialists with roots in both areas, the authors found that there are five hindrances to the integration of sustainability:
- the stark differences in understanding linked to sustainability;
- the lack of resources for implementation;
- the lack of guidance on how to implement;
- the lack of knowledge on sustainability and ESG in VC in general;
- the general challenge of measuring ESG issues.
The study found the hindrances to be interconnected and driving each other. These hindrances impact the sensemaking of VCs when dealing with NVs, and impede the implementation of sustainability and ESG.
But how does it come to the point that sustainable NVs generally tend not to gain VC funding? The study constructed a framework based on research and adapted it through empirical data to the sustainability context. The framework in table one depicts three main points directly linked to the hindrances which impede the funding of sustainable NVs through VCs:
Table 1 – Framework assessing VC sensemaking linked to sustainability in NVs.
Firstly, due to the differences in understanding of what sustainability is, coupled with a lack of guidance, each VC has its individual sustainability expectations. The heterogeneity of expectations complicates the funding search of sustainable NVs, as they have to navigate the general financially driven VCs and their differing sustainability expectations. These varying sustainability expectations lead to NVs needing to adapt their identity with each VC in the hope of gaining funding. Thus, every VC has different sustainability expectations which impact NVs and the way they portray themselves.
Secondly, these differing sustainability expectations also impact the VC sensemaking of a business case. Sensemaking is the individual weighting of factors seen as “normal” and “different”, in which the individual sustainability expectation of a VC plays a major role. A business case is only seen as plausible, and thus legitimate to fund if the individual weighting is acceptable. The study found that a NV’s sustainable business case can be excellent and plausible in the eyes of one VC, but inadequate in the eyes of another. This uncertainty of sustainable business cases, resulting from a lack of guidance and knowledge of VCs on sustainability, impacts VCs’ sensemaking as sustainability is perceived as something “different”. In contrast, financial information is highly regulated, and a shared understanding between VCs makes it “normal”. Thus, differing sustainability expectations and sustainability being seen as “different” impedes the funding search for sustainable NVs. However, it also shows the need for sustainable NVs to balance sustainability and financials.
Thirdly, the study found a general “looking good” vs. “doing good” debate hindering the implementation of sustainability and ESG in VC and NVs. Questions such as “Will people think this is greenwashing?” or “Will society be questioning me if I have nothing green in my portfolio?” impede the judgment of plausibility of a business case, further hindering sustainable NVs in gaining VC funding. Thus, negative narratives around the credibility of sustainable solutions and increasing pressure to show sustainability considerations impede the assessment of sustainable NVs.
The study’s authors argue that these three findings, paired with the five identified hindrances, could be the reason for the paradoxical situation of VCs claiming to want to fund sustainable cases, but sustainable NVs showing a lack of funding. They further argue that if no changes are made to this complex environment, then it will continue to be hard for sustainable NVs to prove that they can do well. Finally, the authors argue that the hindrances must be dealt with to create a universal understanding of sustainability in VC and NVs to enable more investments into sustainable NVs.
About the authors
Emily Maria Goehlmann recently graduated with an M.Sc. in Diversity and Change Management from Copenhagen Business School. ESG and startups are some of her core interests – which have merged into the Master thesis underlying this blogpost. She now works as an Associate for the Sustainability Consultancy Position Green in Copenhagen and worked priorly as an ESG Associate for the Danish Venture Capitalist Dreamcraft.
Kathleen Lameter has recently graduated with an M.Sc. in Management of Innovation and Business Development from Copenhagen Business School. During her studies, she discovered her passion for sustainability, which led her to pursue a Minor in ESG. Kathleen now works as an ESG and Sustainability Specialist at the Abacus Medicine Group in Copenhagen.
Prof. Kristjan Jespersen is an Associate Professor in Sustainable Innovation and Entrepreneurship at the Copenhagen Business School (CBS). Kristjan Jespersen is an Associate Professor at the Copenhagen Business School (CBS). As a primary area of focus, he studies the growing development and management of Ecosystem Services in developing countries. Within the field, Kristjan focuses his attention on the institutional legitimacy of such initiatives and the overall compensation tools used to ensure compliance. He has a background in International Relations and Economics.