VCs are gatekeepers to capital. But can they act for the long term?
If we don’t reward investors and startups for thinking ahead, we might never address our biggest problems.
By Elizabeth Sisson, former Technology and Public Purpose (TAPP) Fellow at the Belfer Center for Science and International Affairs, a research center located within the John F. Kennedy School of Government at Harvard. Elizabeth is also former Chief Operating Officer and investor at Urban Us, a US-based VC fund that invests in early-stage urban and climate tech.
Over the 2020-2021 academic year, with support from the Belfer Center and Technology and Public Purpose project, I tried to answer one simple question: how can we get the most long-term value from startups and investors?
Part of this work has been to establish standards and a practice of diligence that early-stage investors should use when evaluating technology-first startups and companies to reduce the negative and harmful impacts of emerging technology. For example, a company that takes advantage of poor labor practices, uses surveillance-like algorithms for data, or excessively mines natural resources might be very profitable, but ultimately only benefits shareholders at the cost of the environment or the public. The traditional model of VC does not lend itself to patient, thoughtful, or public purpose innovation. With the typical time horizon of a fund being 10 years, VCs need to make money and fast, regardless of impact. But an increasing number of funds and investors are pushing beyond the bottom line by pursuing ESG (Environmental, Social, and Governance) methodologies and impact-related missions. With our research and work, we encourage venture capital investors to take a more expansive approach to diligence, beyond just simple ESG and impact metrics.
This mindset is inextricably linked with public-purpose tech (PPT) startups, and means thinking about long-term value creation rather than just short-term shareholder returns, and thinking about stakeholders such as employees, customers, or the public, overall job creation, sustainability practices, economic growth, solving long-term problems, and adjusting businesses to new regulatory or social environments. Because VC is in the business of making money, part of this long-term value approach is also thinking about growth, revenue, and profits. Through my work, I have seen venture-backed startups without viable business models or sufficient paying customers that simply stay afloat thanks to generous VC backing and quick acquisitions. That type of behavior can rightly be called short-termism, where short-term growth and quick returns comes at the expense of the environment, marginalized communities, the economy, and even long-term financial returns.
What does value mean in the 21st century?
As part of our research, we drafted tough qualitative diligence questions an investor might ask a founder to get a better sense of their values and decision-making around long-term value creation. They are intended for VCs, but startup founders may also find inspiration that can help set their value-add apart in an increasingly socially conscious investment environment.
Example questions to ask to evaluate for long-term value creation:
Does this technology replace existing government functions or privatize them? The public sector is required to act in the public’s interest. If public sector services or products are privatized, it’s important to ensure that essential services remain affordable and available to large segments of the population.
What will it take (growth models, time horizon, policy, etc.) for the company to become profitable? Growth rates depend on a variety of factors: talent, capital requirements, and the size, maturity, and competition in the market. The market can punish premature or non-existent growth, over-inflated valuations, and can cause quick collapses. Hard problems require patient capital and solutions, allowing for course corrections without total failure.
Is the company considering (or already pursuing) a freemium business model in exchange for data? Because freemium is a form of marketing that does not guarantee revenue, companies often have to sell collected data to make up for lost revenue. The commodification of data — and by extension, privacy — may be a business model risk for these businesses and their long-term value creation: are they creating products for paying customers or free customers?
How many ex-employees exercised their vested options? Options reduce turnover during a vesting schedule, which reduces recruitment costs. Turnover is natural, and the U.S. Bureau of Statistics reports that the average turnover rate in the U.S. is about 12-15% annually. Workers have first-hand experience of the potential long-term success of a company. If former workers believe in a company’s long-term success, despite their departure, they are more likely to exercise their vested options.
Is the science or technology at your company backed by university research, government grants, or any other consortiums? Cooperative efforts between academia, public, and private sectors are essential for nascent markets and early business models. Research suggests and history illustrates that establishing cooperative research and development across the private sector, while ensuring that knowledge gained is leveraged by the broader scientific community, fosters long-term growth and scale.
Who ultimately benefits from this? Who can be socially or economically harmed by this?
What time horizon does the company consider long-term?
What could a pivot look like at this company? How does that impact the intended value creation?
Does this business provide incremental (small dent in problem), fundamental (problem mostly solved) or transformative change (problem eliminated or a brand new movement)?
This approach, as opposed to the Warren Buffet strategy of creating long-term intrinsic value for investors or traditional ESG, takes into consideration the uncertain and evolving nature of early-stage technology-first companies and looks beyond metrics alone to also examine possible qualitative outcomes. ESG was not directly developed for early-stage technology-first companies, but developed for large financial institutions and corporations. Diligence should consider internal decisions of technology companies, the external outcomes of these companies, anticipate any possible negative consequences on society, and that information should be utilized in pre-investment decision making or for follow-on considerations. Some companies who perform well in traditional ESG evaluations can cause or contribute to some of societies’ greatest harms: Google, Nike, and even Meta (Facebook).
VCs as capital gatekeepers
For responsible businesses and technology that drive public value and reduce harms, VCs need to take more responsibility for long-term value creation. Climate tech, which is seeing a massive boom in capital and innovation, is a perfect example of where long-term value creation needs to be the top priority; be wary of startups that raise outsized rounds of capital, or are acquired early by oil and gas companies, but ultimately fail to move the needle on climate change. VCs should be held accountable as capital gatekeepers. They have the power to decide the technology the public will interact with and, regardless of their impact or ESG status, should commit to reducing harms and creating value over a 10+ year timeframe.
For more information on how VCs can ensure public purpose values, download the VCPP playbook.
Up Next:
Jaideep Prabhu, Professor of Marketing and Jawaharlal Nehru Professor of Indian Business & Enterprise at the Judge Business School, University of Cambridge
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