"Sustainability" as investment criteria of venture capitalists

The other day I was reading the wonderful German business magazine “Brand Eins” again and came across some interesting interviews with venture capitalists (“VCs”) regarding their investment criteria and to what extent sustainability aspects now play a role in financing innovative startups. I got inspired by the interviews and thought it might be interesting to extract them for you in an article and add my own perspective to them. The result is of course far away from being an exhaustive list of investment criteria. Regardless, I truly believe that the outcome is at least a very nice overview of investment criteria that are relevant to VCs and that you should focus on with your startup.

Team

VCs will always have a close look at you and your founder team. They will ask questions like „What is your intention and motivation?“ Do you get up in the morning because you want to make the world a better place? For example, through decarbonization? Make sure that the VCs understand that you are genuinely passionate about your idea or product and are committed to making it succeed. Even if it means to go the extra mile many times.

Show your passion and commitment - someone who has the ultimate goal of being a multimillionaire in five to ten years is usually not interesting for VCs.

VCs will also look at yours and your teammates' competencies and attitudes. Make sure that you bring unique and complementary skill sets and expertise to the table. This could include technical expertise, industry knowledge, business acumen, marketing skills, or operational experience. A proven track record of success is appealing to VCs as well because it indicates your ability to execute and deliver results. Also the dynamics and cohesion among you and your founder team will be assessed. You must be able to prove the ability to collaborate effectively, communicate openly, and resolve conflicts constructively in order to build a strong foundation for growth.

In a nutshell a well-rounded team that covers key areas of building and scaling a business is attractive to VCs.

Product

Currently, VCs are very keen to invest in markets for products in the areas of climate protection, robotics and artificial intelligence. Especially technologies that can solve social and environmental problems are in focus.

When you pitch to VCs they might ask you questions like what does the company want its product to do? Is the product making a contribution or displacing another market player? Is this contribution realistic and scientifically verifiable? What is the risk that the product will be used for unsustainable purposes? Be prepared to present your business model to the VCs. You must be ready to describe how your startup creates, conveys and captures value.

And what about sustainability? In general, it must be said that not all venture capitalists attach importance to the sustainability of their investments. Whether a VC also attaches importance to sustainability or not depends on the investment strategy pursued by the VC, the values and priorities it has set for itself, and the markets in which it prefers to invest. Although the main goal of any investor is to generate returns, it is important to understand that VCs are also increasingly focusing on sustainability aspects. However, this is not exclusively because they now only want to do good. Here, too, the focus is on opportunities for returns.

You certainly know already that VCs need to make big profits in a short time (usually not more than a decade), and as a consequence they focus on products that are easy to sell and less risky. This objective makes clear that investments into sustainability startups can become a real challenge because technologies that require longer development times often come up empty. Hence the investment approach will still work for startups that develop software solutions like e. g. for ESG reporting. But startups that are working on more complex solutions - mainly development of new materials or new methods - and do much more to combat climate change, have disadvantages because they eat up a lot of money at first and don't grow as quickly.

Keep in mind that VCs also have a product they sell to their investors. This product is called "return". And as a result VCs, of course, continue to try to invest the money profitably.

This does not mean at all that you should not start a sustainability startup. Some developments are already pointing in the right direction. In the meantime, some VCs are waiving the ten year time limit. It is now also important for them across the board to understand what the impact of your startup will be in terms of the environment and society.

To avoid taking too great a risk, VCs usually choose to invest into startups that are already further along in their development. Hence in order to increase your chances of successful funding it actually makes a lot of sense that your startup can prove to them that it made progress in terms of product development, customer acquisition, revenue generation, or has achieved other significant milestones you have set. Demonstrating early traction can indicate market validation and reduce perceived risks on the VCs side which in turn can result in a higher likelihood of attracting financing successfully.

For big ideas in the sustainability industry that are still in the early stages, unfortunately a financing gap remains. So far, only a few venture capital funds have ventured into this area. But I personally believe there will and must be more to come.

Market

Regardless of which market you're playing in with your startup, you are required to have a deep understanding of the industry you are operating in. A substantial knowledge of market trends, competitive landscape, and customer pain points helps the VCs to validate you and your team's ability to navigate challenges and identify opportunities.

VCs are interested to invest in startups that have the potential for rapid growth and scalability. If you are able to articulate the market potential and size of the opportunity, in the sense of a clear vision for scaling your business, expanding into new markets, or capturing a significant share of the target market you are likely to attract the attention of VCs.

Why not position your first or next startup in the sustainability industry? Problems caused by climate change are becoming so pressing and unpleasant, people, countries and companies are now willing to pay a lot of money to mitigate them. Customers are increasingly aware that sustainable consumption makes a difference. They are beginning to even look at the value chains of companies and are also making purchasing decisions with sustainability aspects in mind. Customers want to consume sustainably and with a good feeling. This development has not gone unnoticed by VCs. Hence if your startup offers a good solution to the problems caused by climate change, you will have a market. And if you have a market you will be able to convince VCs.

Reference(s):

• brand eins Wirtschaftsmagazin Heft 6/2023, S. 66-72 / brand eins