How Angel Investors and VC Can Help Solve the 21st Century’s Grand Challenges [Part 3]

There is good news for startup founders looking to combine profit with a positive impact on humanity by tackling what we call the 21st Century’s Grand Challenges (21CGCs). As we discussed in our first post, the UN Sustainable Development Goals (SDGs) and the other lists from leading organizations provide a helpful roadmap for anyone looking to direct their efforts. 

And, as we showed in our second post, many organizations have already stepped up and are currently making some progress tackling the 21CGCs. But more support is needed to make real headway, and that must come in the form of significant funding from Angel Investors and VC. So in this post we’ll look at the ways Angel Investors and VC can help solve the 21CGCs. 

Key points explored in this post: 

• Angel investors and VCs are positioned to fund PPD Startups that are trying to solve the 21CGCs. 
• In many cases these angel investors and VCs are interested in investing in PPD Startups, but they do not act on their interest for several reasons.
• Angel investors are held back by a lack of quality deal flow, a lack of focus on impact, or inadequate belief in the power of businesses driven by purpose.
• Impact startups can generate the same high returns on investment as traditional highly scalable software technology startups. 
• We must begin to plan and scale for profit combined with impact.

Angels Seek Passion in Impact Investing 

We have put a great deal of effort into understanding the motivations and barriers for business angels supporting purpose-driven startups. Our conclusion is that industries and causes lacking previous success stories need investors with both capital and personal belief and passion. Unlike Venture Capital (VC), limited by their investment thesis and funds owned by their investors, angels have the ability to sign a check almost instantly. 

We have interviewed more than 30 business angels based in Europe, the US, and Brazil, all with previous investment experience. The majority had very low or no experience investing into impact startups, though some mentioned their long-term philanthropic activity. 90% of them were interested in investing into startups working on the 21CGCs. Their median preferred ticket size was between $50,000 and $100,000 on average, and they were ready to close three or four deals annually if quality deal flow allowed. 

None of the business angels we interviewed were interested only in startups working on the 21CGCs. However, many had industry or focus area preferences given their previous career expertise, or for personal reasons.

For instance, we spoke with someone who is the former CEO of a European mobile operator and lately a private equity executive who seeks investment deals concerning water and energy sustainability and has actively built a network in Israel and Europe among startups, investors, and corporations. 

Another business angel, with over 20 years as a senior corporate and an entrepreneurial career in healthcare, has been particularly interested in startup investments concerning health technology and biotechnology. These investors could serve startups as expert advisors, potential advisory board members, or informal lead investors, providing crucial confidence to non-expert investors during the angel rounds. 

Three Reasons Why Angels Often Want to Get Involved But Don’t

So what’s holding back investors who are ready and willing to make a difference? We identified three roadblocks. 

Passion Isn’t Always Enough

Many of the business angels we spoke to are interested in chipping into startups solving the 21CGCs.

For many angels, their passion to be part of something that may improve the world around them is a driving force for at least part of their investment. Some mentioned their desire to “feel the heat” of founders who try to disrupt the status quo. Others also mentioned their willingness to open up their Rolodexes and help founders by connecting them with potential corporate customers, other investors, business partners, or key employees. 

We also heard from a few business angels who said—if they got the right opportunity—they were ready to roll up their sleeves and help a suitable impact startup in an executive manner. Approximately one-third of the business angels we interviewed wish to remain passive minority investors and have no desire to executively influence the business.

But there are still major hurdles, even for those angel investors who feel passionate about investing into companies tackling global challenges.

Lack of Deal Flow Stands in the Way 

Many of the angels we interviewed said they generally lack quality deal flow. Mostly they receive investment opportunities randomly through cold emails and via personal referrals from fellow business angels. 

These angels may not have a structured approach to vetting and selecting investment opportunities. Many business angels told us they would invest more into startups if they had better deal flow. Many times then, they invest into alternative investment options such as stocks, bonds, or private equity. 

Improving the landscape is one thing, but a majority of VCs still prefer profit over social impact. 

Traditional VCs Are not Focused on Impact 

Traditional early-stage venture capital firms have proven to be ill-prepared to work with the majority of PPD Startups we have spoken to. VCs are mostly financial managers working on behalf of their investors (Limited Partners), who seek high returns within the typical 10-year investment horizon. 

So the investment partners of venture capital firms typically invest into categories with existing success stories (exits, IPOs) or recently hyped capitalization curves (a growing number of VC deals). 

Only some focus areas of the 21CGCs—like healthcare software technologies (mostly AI-driven software)—fit the criteria of most VCs. Many other focus areas, including energy sustainability, misinformation, and safe AI development seem to be industries with little or no exit traction, unproven business models and high capitalization needs (as many solutions require a hardware component or selling to governments with long sales cycles). 

We found a number of traditional early-stage (Seed / Series A) VCs with some portfolio companies that could fit our criteria of working on the 21CGCs, but these investments were made with no particular focus on impact investing.

Still, it can’t be denied that investments into PPD Startups are getting traction and more understanding. There is a common consensus that a growing movement towards sustainability is inevitable. But it remains to be seen whether this lack of motivation to support PPD Startups will change with the growing public pressure to focus more on impact.

But pioneering PPD investment funds haven’t fully proven their success yet. According to an interview with a healthcare-focused private equity insider in the United States, there is not a single climate-focused fund that has positive DPI (distribution positive invested) to date, so they are all losing money, despite several decades of development. 

We see many VCs focusing on deep tech startups that are working to solve a variety of core problems rather than shorting impact by supporting simple software applications that do not have the ambition to solve the root causes of their targeted challenges.

Now let’s take a closer look at some of these inspiring examples of VCs backing successful PPD Startups. 

Do PPD Startups Generate High Returns for Investors?

From the beginning of our research, we held onto one hypothesis: 

Impact startups can indeed generate the same high returns on investments for their capital investors as traditional highly scalable software technology startups.

Our experience over years of being founders and CEOs of startups has taught us that many business angels seek returns exceeding 300% on their investments, ideally within the horizon of 10 years. The average returns of investments reaching 1.5x to 2x returns are more common, and many consider 5x return a successful investment. 

Early-stage VCs seek 10x to 100x returns by betting that one or two startups in their fund will become billion-dollar unicorns paying off all their losses (with a hefty profit), which come from the fact that the majority of other startups in the fund are loss-making or netting zero for their investors. 

Having scaled our own startups in past, having raised over $7 million from a variety of VCs and business angels, and having subsequently sold this company to a NASDAQ-floated technology company in the case of one of our previous ventures, we learned that attracting respected profit-seeking investors gains the trust of further investors wanting to chip in, along with talented professionals wanting to join the company executively, and corporate customers seeking commercial partnerships. 

In other words, being a profit-seeking, highly scalable technology venture attracts quality investors, talented employees, customers and business partners, ultimately increasing the chances for a successful exit with high returns to investors (as well as the founders and employees with stock options). 

Planning for and Scaling Profit and Impact

During our research, we found that many non-software impact companies deliver very low if any return on investment. Often their addressable market is too small to build large-scale operations, or the product is not easy to scale because it has a high dependency on human labor and thus does not allow exponential scaling of the business. You may find some exceptions, such as Tesla and other hardware companies often highlighted by the media, but for every positive example, you can easily find a hundred negative examples that support our argument here.

Many impact-focused investors said that they regularly speak with founders who do not actually have the desire to scale their business and deliver potentially high returns to their investors. Moreover, some people we spoke to questioned whether profit-seeking investment into PPD Startups is a good idea at all. They also questioned whether investors shouldn’t consider turning their investments into philanthropy instead.

After analyzing fundraising data from several PPD Startups both in Europe and North America, we have also confirmed our hypothesis: 

Many PPD Startups require high investment checks in order to scale their businesses. 

Hardware companies generally deliver lower return potential because founders need to spend considerably more on product development than their software-only peers. 

For example, Dot.Glasses, a hardware-only startup producing low-cost optical glasses intended for third-world economies, has raised just over €1 million during five years of existence, despite proven traction and global ambitions. The company raised 453,000 Czech crowns (€17,000) in a crowdfunding campaign, followed by a €1 million seed round led by Tilia Impact Ventures, an impact fund. 

Startups that require extensive licensing and government approvals are generally expected to be more capital-intensive (increasing equity dilution, but not necessarily returns on investment). Startups providing service to governments generally have much longer sales cycles and high certification expenses, and thus require higher investments at an early-stage compared to B2B enterprise startups.

Some startups in healthcare “hack” their struggle with high capital needs by designing their businesses for early exits as they fight high costs and barriers of entry for later-stage clinical testing. This practice, if done successfully, can show the way for some PPD Startups in other focus areas to provide relatively fast exits although with lower valuation and respective positive impact.

Ezra, a technology startup that provides an AI-driven software that identifies cancer tumors, has reported comparable growth with traditional tech startups, with $4 million fundraised in 2018, one year after incorporation, and with $18 million follow-on Series A 14 months later with prestigious FirstMark traditional VC funds leading and participating. The founder has attracted prestigious angel investors, including the CEO of UI.Path, a fast-growing technology company, arguably thanks to his previous entrepreneurial experience. 

Emi Gal, the CEO of Ezra and a PPD Founder himself, noted in an interview that his success with the fundraising seed round and consequential Series A round wouldn’t have happened without his “previous entrepreneurial success.” He confirmed that building a PPD Startup in healthcare is harder than in traditional startup industries, due to regulations and the high stakes related to the involvement of human health. Without prior knowledge of the healthcare sector, the CEO hired a specialist CTO after cold emailing hundreds of candidates. He reportedly won the trust of first customers and investors by hiring more than 20 expert advisors to various advisory and board management roles.

We are happy to see this movement in the right direction, with more VCs and angels feeling motivated to combine profit and impact and support those PPD Startups that are trying to tackle the 21CGCs. There is still no exact formula for success, but there is a growing number of examples of successfully funded companies that are making profits and impact. 

When BlackBaud, a cloud software company, acquired Justgiving, a pioneering social giving platform in 2017, the widespread media coverage in the UK contributed significantly to the popularization of PPD Startups. We would argue that there should be more media space dedicated to such public success stories, both in the local and the international press.

But more work remains to be done to pave the way for PPD Startups and to motivate investors to back these companies. In the next post we’ll take a look at how PPD Startups trying to solve the 21CGCs are still struggling—and we’ll talk about ways we think their struggles can be overcome.