Why rigorous impact due diligence is important for impact venture funds
17 April 2023 8 minute read
A conversation between David Neaum, Senior Consultant in Impact Investing at NPC and Lindsay Wake, Head of Impact at Social Investment Scotland.
At NPC, we believe that all kinds of capital has a role to play in making an impact on society and the environment. We are encouraged by the recent launch of ImpactVC– a Europe-wide collaboration by over a hundred venture capital firms to promote impact investing in venture capital. ImpactVC will work with both aspiring and established venture fund managers, to promote integrating impact due diligence in their investment process.
NPC has a long track record of supporting fund managers on this journey. One of the funds we’ve supported is SIS Ventures, who approached us in 2018 when Social Investment Scotland (SIS) were setting up their Impact First Fund. SIS was looking for an impact partner to help develop the investment process that would assess and measure the impact of their prospective investments. Since 2018, we’ve provided SIS Ventures with external impact support, supporting set up of a robust impact due diligence, measurement, and management system at the firm. As NPC supports SIS Ventures to grow its internal capacity, we spoke to them to get their views on the importance of rigorous impact due diligence and how one can deliver it.
David: Hi Lindsay, could you say a little about why SIS Ventures wanted an impact partner in the first place and what expertise you were looking for?
SIS Ventures is part of Social Investment Scotland (SIS). SIS is an established and leading social investor with more than 20 years-experience of supporting social enterprises and third sector organisations to create and scale their impact.
Over a period of years, we noticed increasing interest in impact-led enterprise models from business founders looking to solve society’s problems and develop responsibly run companies. With SIS’s impact credentials firmly in place, SIS Ventures felt like a natural next step. While more commercially focused, SIS Ventures wanted to put impact diligence and performance on an equal footing to financial diligence and performance; we wanted to prove that purpose and profit and can be equal partners; and that impact can drive commercial success. We wanted to shift traditional investment decision-making from a sector focus to an outcomes-led approach.
Given capacity at SIS, and that we were already running a number of social impact funds on behalf of investors, we needed extra support to establish the best impact diligence processes for SIS Ventures. Establishing SIS Ventures was a two-year project; we needed to set up a new entity; become FCA registered, develop an equity investment product, and attract external investors. It was a busy time and bringing in an external expert added capacity where it was needed.
We were also acutely aware of the dangers of impact washing and wanted to work with an external partner to provide further expert advice and external scrutiny. Initial externally led, impact due-diligence and verification of investments has helped establish a strong degree of consistency and validity around how the SIS Ventures team thinks about impact.
David: What support did you need initially and how has that changed over the years?
I think the main support initially was help in setting up a due diligence framework to assess impact. We wanted to consider all of the relevant best practice frameworks and incorporate these into our diligence processes. Once established, we wanted support to develop our skills in impact conversations and impact measurement and reporting. This wasn’t new to SIS – we have been carrying out impact diligence, measurement, and reporting for years for SIS loan funds. But it was important given the ‘for profit and purpose’ focus of SIS Ventures investments that we established the right, and robust, impact diligence process from the outset.
Once we had established the framework, we worked alongside NPC to carry out our impact diligence and early impact practice support for investees. This ensured robust consistency in processes and allowed us to refine, deepen and strengthen the approach over the initial early years. It also meant we were able to develop best-in-class portfolio-monitoring – which has highlighted some interesting insights as investments mature.
David: What has been the experience of your investment teams in working together with NPC on supporting the portfolio companies/investees on thinking about their impact? Where was NPC’s input particularly helpful?
We’ve always had a mature and valued relationship with NPC. After co-establishing original frameworks and processes, it has been a journey of mutual learning and knowledge-sharing which I credit for the pragmatic, realistic and effective impact management practice we now have in place. Being able to bring sector best-practice approaches under the guidance of NPC, combined and refined by real life experiences working with portfolio companies, has resulted in a unique and leading impact management approach. In fact, we are delighted to be Scotland’s first verified signatory to the global best practice standard Operating Principles for Impact Investment (and one of only a few in the UK) and NPC supported this process as a ‘critical friend’.
We’ve found it particularly helpful to have an external eye when making judgements about impact and assessing impact. Being able to express viewpoints and share evidence of impact achievements and barriers, between the SIS Ventures team and NPC, has helped us to reach consensus and a fair representation of impact achieved. It has also been a valuable learning experience for the team.
David: What’s the biggest thing you’ve learnt about balancing impact due diligence with financial due diligence?
Our approach at SIS has always been to think impact-first. This is the lens we bring to all our investments – regardless of the type of fund. For SIS Ventures that provides early-stage equity funding, we have learnt that tools and toolkits for impact diligence in impact investing are still evolving. There are best practice frameworks we can adopt and engage with – but translating these on a practical level takes knowledge, skills, and time. We’re really proud and confident in the impact diligence process we now have, as that is grounded in impact management best practice. We are now busy digitising it so that the back-end data gathering, scoring, monitoring, and reporting mechanics are more efficient and can be applied more easily for other investors developing impact diligence processes.
David: The aim has always been for SIS Ventures to build up its internal capacity. Some organisations may want to retain external impact services and some may want to develop their internal capacity. Can you talk about how NPC is supporting you to achieve your aims?
We’re in the middle of a programme of training for the SIS team. Out impact team is growing, and we want to ensure that those coming into the team are able to carry out impact diligence with the same level of knowledge and scrutiny as NPC has brought to SIS Ventures’ in the early years. There are also processes and approaches that are useful to understand more about, as you don’t naturally see everything that happens behind the scenes in terms of impact research and thought processes and we’ve found it useful to make these visible and talk them through
In the future we want to evolve our relationship so that NPC becomes more of a critical friend. At SIS we keep a watchful eye for impact practice development and continually seek to make improvements and align with best practice – having an external view on this too is helpful.
David: Based on SIS Ventures’ experience, what advice do you have for other fund managers who are looking to raise impact venture funds especially around impact measurement expertise?
I would say that this is an evolving area where there needs to be a focus on developing skills so that investors are as confident and capable in impact diligence, as they are in financial diligence. It is an important, developing, field – especially if we are to ensure that the world’s capital is deployed where it can make the most impact (whilst minimising any unintended consequence or negative impacts). There are experts, frameworks and a growing number of tools to aid with this and so seeking out those who can help, and learn from those who have gone before, is a good way forward.
David: Thanks Lindsay, it has been a pleasure working with SIS Ventures and it is exciting to see the impact that your portfolio is already creating and the ways we are able to report on that. We look forward to next phase of our learning journey.
If you are thinking about or developing your impact practice and would like to learn more or enquire as to how NPC might support you, please do get in touch with David.Neaum@thinknpc.org or Gurmeet.Kaur@thinknpc.org
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A light-touch and practical framework for comparing an organisation’s approach to impact against best practice.
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