Photo by Brian Aoaeh
Note: This article was inspired by and based on an email exchange with Anton Kabisch and Marco Cesare Solinas at Blue Future Partners. It was originally published at Innovation Footprints on November 12, 2021.
Summary: Although it is difficult for early-stage technology startups to meaningfully measure ESG and Impact investing outcomes, we believe that as supply chain technology investors these are considerations we have to take into account whenever we make an investment decision. At REFASHIOND Ventures we have created an approach that we believe does a satisfactory job of qualitatively assessing potential ESG and Impact outcomes at the point at we make an investment decision, while we monitor startups’ progress till such a time that we can meaningfully and accurately measure ESG and Impact KPIs and metrics; In essence we separate investment underwriting from ESG and Impact measurement, while ensuring that ESG and Impact investing considerations remain a critical aspect of our investment underwriting process.
Introduction
The publication of the Sixth Assessment Report of the United Nations Intergovernmental Panel on Climate Change (IPCCAR6) has caused investors to revisit environmental, social, and governance considerations (ESG) and their place in the framework of investment decision-making. Simultaneously, reports like The State of Climate Tech 2020: The Next Frontier for Venture Capital by Dr. Celine Herweijer and Azeem Azhar point to the growing interest in the role investors can play in determining how the world tackles the problems that are direct and indirect causes of the Climate Crisis.
More recently, in Venture Capital Firms Are Fighting to Throw Money at Cleantech, published on September 2, Bloomberg’s Nathaniel Bullard reports that venture capitalists have invested a record-breaking amount of capital in climate technology in the first 6 months of 2021.
The 26th UN Climate Change Conference of the Parties (COP26) which was held in Glasgow from 31 October – 12 November has put supply chain resilience and agility on the front burner for governments, civil society organizations, businesses, and investors in both the public and private markets. We believe that resilient supply chains have to be agile as well, and this is where technology and innovation play an essential role.
Moreover, as our team at REFASHIOND Ventures has had conversations with potential limited partners about their participation as investors in REFASHIOND Ventures’ first institutional fund, the question often arises about how we incorporate Impact and ESG investing considerations into our investing process as early-stage supply chain technology investors.
Supply Chain Innovation & Technology, ESG, Climate Change, and Impact are the Same Issue
Our focus on supply chain technology at REFASHIOND Ventures is driven by a simple belief; Human activity is causing climate change. All human activity is driven by supply chains. To solve the climate crisis we must refashion, reinvent, and transform global, man-made supply chains so that we reverse the damage humans have caused to the natural environment. Moreover, we also argue that innovations - technological, process, business model, or regulatory - that enable sustainable supply chains to take root and scale, form the basis for all other sustainability initiatives.
Supply chain and the climate crisis are opposite sides of the same coin; Humanity’s collective supply chain design choices are the cause, and the Climate Crisis is the effect.
As a result, ESG and Impact considerations are a fundamental and innate aspect of how we think about the investments that our fund makes. That said, it is worth pointing out that how one implements an ESG and Impact framework for a company that is still in its embryonic stages of development must necessarily differ from how one implements ESG and Impact considerations for mature incumbent companies that trade on the world’s stock exchanges, for example.
For early-stage technology startups, it would be counter-productive to impose a detailed reporting and compliance framework that the startup must adhere to in addition to the numerous other challenges such a startup must confront. For the purpose of this conversation I am defining an early stage startup as any startup that has not yet found a business model that is repeatable and scalable AND that has raised less than $100 million cumulatively from external investors.
The framework we have developed for the startups we assess for an investment from REFASHIOND Ventures comprises a standalone ESG section of an Investment Decision and Review Scorecard that each member of our investing team is required to complete for every investment that progresses to due diligence. Altogether, the scorecard covers about 50 questions split across 5 unique, but interconnected sections, which we believe are important for each person on our team to think about as we assess the startup for an investment.
The ESG Considerations section generates a quantitative score based on the REFASHIOND Ventures team’s assessment of the startup’s potential future characteristics in 6 areas related with ESG investing. The questions ask reviewers to score the startup being assessed on a scale from 0 - no basis on which to form an opinion, to 5 - among the very best the reviewer has encountered for a startup at this stage. The score for this section is then combined with scores generated for the other 4 sections of the scorecard to create a single combined score.
Another way of thinking about this is that our team separates the underwriting of our investments from the measurement, tracking and quantification of ESG and Supply Chain Impact key performance indicators (KPIs) and metrics because for early-stage investors the investment must be made before it is possible to track KPIs and metrics in any meaningful way. For example, we may be investing in a pre-seed startup that does not yet have a product customers are using.
The goal of our ESG review is to develop a qualitative assessment of what we believe will happen if the startup succeeds and matures; Will it have an altogether positive impact on the environment, or will it have an altogether negative impact? Will it lead to higher GHG emissions, or will it lead to lower GHG emissions? How strong is our belief? This is how we ensure that we do not entirely ignore ESG and Impact considerations during our investment underwriting process.
We do not invest in startups that we believe will contribute to the climate crisis as they succeed, nor do we invest if we feel success will not lead to clear, measurable, and positive ESG and Impact outcomes.
Our ESG Considerations Review Focuses on Areas We Feel are Most Urgently in Need of Innovation
The ESG Considerations section of our Investment Decision and Review Scorecard asks members of our team to make an assessment of the potential for the startup’s technology and innovation to have positive and scalable impacts on the following ESG issues:
Reduction in Greenhouse Gas emissions.
Reduction in the generation of material waste.
Reduction in water waste and pollution.
Increasing the rate of creation of jobs that pay a sustainable living wage and contribute to the economic wellbeing of communities.
Meaningfully improving the environmental conditions within which employees in the supply chain work.
Increasing supply chain transparency.
Reduction in the negative environmental impact of industrial supply chains in the particular industry that the startup will target for its customer base.
Finally, each reviewer must make an assessment of the innovation’s potential to have an overall positive impact on supply chains and value chains in the relevant industry. At the very beginning of our investment review process, we ask startup founders to identify which of the 17 United Nations Strategic Development Goals align most closely with their business when they fill out our data-intake form.
As I have pointed out already, the climate crisis and the choices humanity has made in designing, building, and managing man-made supply chains are intricately linked; One may say they are opposite sides of the same coin. The intensity with which fossil fuels are consumed in the production, storage, transportation, and consumption of goods and services is the single biggest driver of the climate crisis; This is clear from IPCCAR6.
Our Investment Categories Mesh With ESG and Impact Considerations Across Industries
Next Generation Logistics is an important area of focus for us because of the immense impact transportation and logistics has on global GHG emissions. We believe that Data & Decision Analytics is closely related to Next Generation Logistics, because this is what makes it possible for companies to use the power of computational techniques and other exponential technologies to understand how various choices in their supply chain logistics networks might lead to positive or negative outcomes - at the strategic, tactical, and operating levels of each company's organizational hierarchy.
In our investment thesis and framework, Data & Decision Analytics is about the marriage of data science, machine learning, dynamic systems, stochastic optimization, and computer simulation into easy to use cloud-enabled platforms that large, small, and medium size enterprises can deploy to assist c-level executives, middle managers, and frontline employees who have to make tough choices and decisions under uncertainty, in different but related work environments.
What producers make, and how producers make what they make contributes significantly to the ability of industrial supply chains to meet ESG and Impact considerations and requirements. Therefore, REFASHIOND Ventures seeks investments in Advanced Materials and Advanced Manufacturing. We are especially interested in the ongoing and accelerating shift away from linear supply chains and towards circular and regenerative supply chains.
We are exploring the emerging area of demand chains, as some people refer to them, where production is only initiated after a customer has made a purchase. Demand chains promise to reduce the problem of unsold inventory that is disposed of in ways that cause pollution.
The most exciting innovations that will transform global supply chains are those that deploy the lessons from the software, information, and computational technologies developed over the past half-century or so with the industrial processes and physical systems engineering on which human civilization has been built to create innovations that reverse the harm we have caused the environment; The increase in severe weather events all over the world suggests that we are at a unique inflection point in the history of mankind’s relationship with the natural environment, but we also know that that the world has sufficient capital to empower technologists and innovators to lead the efforts to apply their expertise in helping society realize the goals of ESG and Impact investing considerations which is, essentially, to replace businesses that destroy the natural environment with those that cause significantly less harm to the natural environment.
Measuring ESG Compliance at the Early-Stage is Hard, but not Impossible
We are just getting started building the fund, so at this point we are focused on assessing if the startups in which we invest continue to maintain their focus on actualizing the potential positive long term ESG outcomes that could occur if they reach scalability.
As I have already stated, it would be counter-productive to impose a detailed reporting and compliance framework that the Pre-Seed, Seed-Stage, and some Series A startups we engage with must adhere to in addition to the numerous other challenges they must each confront and overcome as they seek a path to a profitable, repeatable, and scalable business model.
At each subsequent round of financing that occurs in the future, our team will conduct another bottom-up, comprehensive review of our own to assess how things are evolving. As the startups mature, we will work with the other investors and the company to determine the best approach to ESG and Impact compliance. Note that compliance might be the wrong word, since regulations have not yet caught up with reality and so “compliance” in this context refers more to voluntary reporting that is not yet mandated by government regulations.
We do not think this will be particularly difficult, since most of the founders we meet demonstrate an innate commitment to ESG and Impact issues, and they personally express a commitment to contributing to solving the Climate Crisis. In every case, this attitude predates their conversations with REFASHIOND Ventures. Moreover, our observation is that many have been encouraged by their customers to start trying to track ESG and Impact KPIs and metrics much sooner than we might have expected, or suggested.
How Early-Stage Venture Capitalists Can More Effectively Engage with ESG and Impact
Early-stage innovations and technology are most useful as companies try to gain control over the GHG emissions across their extended upstream and downstream supply chains, and as industry working groups develop collaboration strategies to gain control over emissions within industry-wide value chains. This is a topic that is explored in a January 2021 Insight Report published by the World Economic Forum and BCG, Net-Zero Challenge: The Supply Chain Opportunity, which delves into some of the steps that corporations can take on the path to decarbonizing their supply chains.
REFASHIOND Ventures’ investment thesis is predicated on the belief that the transformation that man-made supply chains will undergo as the world confronts the climate crisis presents the biggest investment opportunity that exists. There is increasing evidence to support that assertion. For example; A report published on October 27 by HSBC and the Boston Consulting Group (BCG) estimates that global supply chains need USD100 trillion of investment by 2050 if they’re to achieve net zero – and as much as half of it is required by small and medium-sized enterprises (SMEs). On September 24, Goldman Sachs published Carbonomics: Five Themes of Progress for COP26, in which the authors state that they expect a cumulative US$56 trillion “of green infrastructure investments to meet Net Zero by 2050' in our GS 1.5° scenario, driving technological innovation throughout our Carbonomics cost curve.”
I believe that every climate tech investor is really a supply chain technology investor in disguise. Similarly, every ESG and Impact investor is really a supply chain investor hiding in plain sight. Why do I say this? The outcomes that climate tech, ESG, and Impact investors seek can only be actualized through man-made supply chains and how those supply chains interact with the natural environment and society.
Venture capitalists should work on understanding the intersection of supply chains, innovation, technology, ESG, Impact, and the Climate Crisis. That is the starting point. As we say at The Worldwide Supply Chain Federation; “The past ran on supply chains. The present runs on supply chains. The future will run on supply chains. The world is a supply chain.”
Additional Reading