E479 | Cyril Gouiffès, European Investment Fund (EIF): What It Takes to Be a Real Impact Fund Manager

32:33It is an investment activity. It's an early stage investment activity, so things do not go always as we expect. I mean, that's in the end, And venture capital is, in many languages, also called a risk capital. So, yes, that's an investment class. That's an investment strategy that involves a high degree of risk. Risk being not being able, as a fund manager, to return the fund to your investor or to meet the success you actually raise your fund for. So I do confirm we have systematically or almost systematically a positive correlation between financial performance and impact performance. We have funds that we already know, impact funds we already know, will not be able to return the entirety of the fund to their LPs.

33:23It's obviously and thankfully an exception in our portfolio, but these cases do exist. For these cases, what led to the incapacity of the fund manager to return the fund is certainly, as in any investment activity, the investment decision targets or the portfolio companies that were eventually invested or supported did not make it to the local, regional, global success that was inside, let's say, for the fund manager when it decided to invest. And in these funds, you often find a positive impact performance. So there are funds for which we do see a decorrelation. Companies, it's an equity business, so companies don't get sold.

34:13So the financial value of the fund is decreasing. The companies of the underlying, the assets of the underlying portfolio are decreasing in value. This being said, it has for a certain period provided and generated the positive impact. it was after. So it was never, we do not have, thankfully, in our portfolio, some kind of impact mistreatment. But we do see impact failures that are triggered by the fact that those companies have not made it. So the impact is not sustained. So the objectives are not met. Doesn't mean that there is a decorrelation in a way that impact is poor, but financially, the company has become a hit and has returned a fund three times this we don't see.

34:57So the most disappointing stories in our impact portfolio are companies, so to say, that certainly have a great impact idea and a great impact thesis, but did not survive the startup phase. What's also important to mention is that after mentioning a few exceptions, after mentioning that we generally see a very strong correlation between financial performance and impact performance, What is also true is that we generally see that impact funds compared to VC peers take longer to materialize value optics. And this is not always the case, but this is a bit of a pattern because this is in general the case.

35:42The reasons for that are manifold. I would perhaps mention two in particular. One is that financing rounds for an impact company tend to be longer, to take longer than it is for a pure take-only focused company that perhaps will raise in the very early growth, provided it's a strong growth every 12 months, perhaps even shorter than that. in the impact space is slightly longer. That would be, again, it's difficult to drop general fingers, but an impact company closing two rounds in less than 12, 18 months is rare, very rare. It's more generally perhaps somewhere between 24, 36 months in general.

36:28So that explains why it's not incapacity to generate value. It's more a value that takes longer to materialize, which also in itself, and perhaps we'll touch about it, question the fundamentals of the impact industry. Again, we've had this conversation many times. Is a 10-year closed-end fund the most suitable financial product to maximize the impact of a startup? I mean, I don't want to answer that question, but I'm convinced it deserves to be asked. So there is a time element, but the fundamentals of the industry being more than 10 years in it, I remain very strong. And I remain very much convinced that not only it is a relevant investment decision, a smart investment decision to invest in an impact fund or an impact company, but I would also argue that going forward and having in mind the world we live in, the challenges we're facing as a society, it will be harder and harder to justify investing in an asset class that has exclusively a financial target.

37:39I would turn the question the other way around and I would say it would certainly be harder and harder. I'm not naive and I know the world we live in, so I'm not saying it will be impossible. But you will need to build a pretty strong narrative to invest in a company, a fund, an asset class in general with the sole compass of generating short-term values for your stakeholders. that may become a way too risky strategy for us collectively as a society going forward. And to that point of bringing financial goals and impact goals together and thinking about correlation and thinking about setting up a financial system that can do that effectively in the future, I'd love to talk to you a bit about impact carry and EIF, but also you personally have been one of the architects of impact carry.

38:27You've seen it play out more than any other investor over the last decade. I wonder if you could briefly touch on the thesis for implementing Impact Carry, so the reasons for having it, but then especially get into some of the lessons learned, some of the challenges, some of the things you've seen sort of happen over the last 10 years in implementing and watching Impact Carry play out in the ecosystem. Pretty simple to share why we as EIF and as a team decided to move ahead and become that stable source of funding for European impact fund managers. I recall very much a discussion at the time between EIF and BSE on this particular topic, and we've mutually nurtured our reflection, I believe.

39:11But the number one, even before closing the first investment in the space, we had very strong views around the fact that impact investing cannot afford to be just a fancy terminology to classify an investment strategy. There needed to be more than that. And basically, we always have been of the view that impact investing without careful measurement but also accountability would be impact washing. So we felt if we were to set ourselves the goal to become the stable source of funding for impact investing in the next decade, hopefully more, it cannot be that the impact objective that you set to yourself as a fund manager and that you are by the way selling to your prospective LPs in the due diligence phase you cannot afford as a as a fund manager to just put forward these impact objectives in your investment deck when it comes to raise the fund and forget about these objectives once your fund is raised and your subscription document side.

40:19So we wanted to find a system that would allow the whole value chain from entrepreneurs to fund managers and fund investors be accountable for the impact that is achieved or not achieved. And this is why very quickly it felt to us that it could not be simply ensured through reporting. We know what happens to reporting even though you potentially have to disclose very poor figures on your impact performance as a fund manager in your Q3, Q4, or annual report, this is basically it, right? You are displaying bad figures, but consequences are not so clear. Yes, there will be certainly difficult consequences in terms of reputation, but we wanted more.

41:05And this is why we came up with this idea of tying the carried interest to not exclusively financial performance that has to be here anyhow for carry distribution, but also impact performance. I don't know to what level of details we want to enter there, but basically, you asked me to get on the principle. If there is one principle that prevails for us to implement this impact-based carry interest is the accountability we wanted to create around impact achievement. So that means, in essence, you raise an impact fund, you invest in companies, those companies do super well, you return the fund. As a fund manager, you are entitled for a share of the financial value that has been created.

41:53This share will be distributed to you as a fund manager if and only if also impact objectives are met. And it sounded for us like something fundamental. Again, in our capacity as a public investor, if we are to play on the market infrastructure, if we are to play on the so-called goods practices. This was, to us, one of the very strong safeguards of the industry we wanted to put in place when starting. Perhaps I can also elaborate just a moment saying that when we started presenting this approach to other LPs or discussing it with fund managers that were coming to us to raise an investment, that raised a lot of doubts and a lot of questions.

42:34this idea to tie the carried interest to impact performance and not exclusively to financial performance and to tie the carry to, yes, first and foremost, financial performance, but also impact performance. Because we heard stuff like, yeah, you're playing with the alignment of interest here, so it's dangerous. I mean, perhaps with this mechanism, you de facto, let's say, have the carried interest that you decrease the visibility of the fund manager on its capacity to eventually at one point get the carried interest. which in turn may have very severe and adverse consequences on the success of the fund.

43:09And so this is a tricky area you're touching on, and we believe it could turn very counterproductive. Spare you the details, but 10 years or 15 years down the road, it's fair to say that this has become a market practice. It's very difficult nowadays to raise an impact fund and say to your prospective LPs that basically carried interest is not subject to impact performance. so this methodology and approach has gone a long way and second and that's to me uh the funniest or the the the yeah the the best anecdote on this but i think is that now we see it has become a usb including in competitive rounds we have i have plenty of stories of impact fund managers who have had access to an investment in a startup that was approached by several other VCs.

44:02And that entrepreneur decided to have that impact fund manager in the cap table precisely because they knew their interest from an impact perspective would be very aligned. Because impact performance would be quite important as the financial growth, the scale, and the financial potential of the company if you have this investor on board. And this is something I find pretty enlightening and interesting to see. The competitive dynamics there are really, really interesting. And the sort of reverse audit of company up to VC or VC up to LP about how they think about some of those things. And I think from my perspective with the LP hat on, I would agree it's become increasingly prevalent across Europe for VC funds, particularly those based in continental Europe to raise with a an impact carry structure in place not least given sfdr sort of pushing folks in that direction from a regulatory perspective as well but i guess some of the um and i think it's been a really strong success story in in that sense and i think some of the challenges we also hear from from vc funds that i'm interested if you you hear as well are around appropriate metric setting appropriate levels of ambition in the the targets they're setting against those metrics, ensuring that the LPs that are interrogating whether those are the right targets, whether they are the right metrics, are further away from some of the companies at the point that the VC is suggesting that those are the right targets and metrics.

45:27So there's a sort of information imbalance. And how have you, I guess there's a range as a consequence in terms of how well people have taken this on board and done it in a more or less sophisticated way. What are you seeing from the firms that do this well versus the firms that are getting caught up in some of the challenges here? Or what do you see are the challenges that are ones that actually the model might need some tweaks? And how are you thinking about some of those? To answer your question, I need to go into a bit of detail, but it's true that for this methodology to work, for this approach to work, this accountability around impact approach to work, a few elements need to be complied with first of all the indicators need to be discussed and defined between the entrepreneur and the investor not with the fund lp we believe because this is how you get to this that level of comfort that the indicator is very intimately linked to the business model of the company and therefore that makes it easier to monitor and report but perhaps most important that makes it more relevant to track and to tie, let's say, your quality success assessment to that particular indicator because it's an indicator that is fully attributable to the company and on which you have a relatively strong level of control.

46:47Therefore, this indicator, you track it and next to that, it's easier to set a target and the target, quantifiable target that you set at the moment of the investment on this indicator as an investor in a company needs to embody or needs to correspond to not maximization of the impact, but the validation of the impact thesis. And you can do that if and only if you have an indicator that makes perfect sense with the very core business model of the company, first element. Second, the investor, the fund LP are not involved at that point of the discussion, but they're involved later on. So ex-post LPs are asked to opine, validate, vote on the impact indicator and the impact target.

47:39So that's where it becomes tricky indeed. And we are seeing this methodology applies across all 140 funds I was alluding to earlier in our conversation. But there are different ways to do it. That's for sure. And we see different practices. So there is no free ride made possible because LPs in the fund are asked to validate the impact scorecard. So it's not as if you have the fund manager or entrepreneur discussing on their corner, agreeing on a potential impact scorecard, and the LPs having no say, no control whatsoever on that impact scorecard. The first element. But it's also fair to say that there is no sub-party validation, neither on the indicator.

48:21and on the target. And this is the case because, again, that has to do with our role of pan-European investor. This is something we cannot ask for. This is something we cannot ask for because we're investing in markets where you would have, you know, at the level or critical mass of consultants of companies who are skilled, sophisticated enough to get to a validation of the impact or figures consolidated by a fund, not in every single market. So this is something that cannot be passed as requirement of ours, generally speaking, for the pan-European mandate we manage. The principle I mentioned prevails across all funds, but auditing, having a self-party validating the figures, is something we cannot implement so far.

49:07Even if we cannot implement, it doesn't mean we don't like it. We do like it. Actually, we are convinced it makes the scorecard stronger. But again, with one objective in mind is to gain in credibility and strength for the market as a whole, not simply to tick the box in another EIF process. This is something we don't ask for. This is something we welcome. And whenever we're asked, we certainly have the opinion that it makes your impact test stronger as an impact fund manager to not only have your carry tied to impact performance, but also have all the figures related to your impact performance audited by a third party.

49:50You know, same as you have accountants, you have audited financial statements. So I'm deeply convinced we are getting there. The pace at which we want to get there is the whole question. That could soon become an overkill for a market that is already fragile, I don't know, but certainly it requires a high degree of care to flourish and grow as we expect. So I'm convinced this is where it heads to. I'm not sure today is the right moment to impose that on each and every LPs, sorry, our GPs. This being said, I stress again that some funds do it. And some funds do it, the ones who do it, I think, obviously, see their USP even stronger.

50:35But that's, again, provided you have the right level of competencies on the ground to not only understand your impact approach, but validate your impact approach. Because that could also become very detrimental, including in a very sophisticated market where you have plenty of impact fund managers, where you have plenty of impact consultants fit to provide such an audit. that could backfire also very well. If there is a misunderstanding on the impact approach of a fund and suddenly the audit cannot be signed or validated by a consultant or company in question for X or Y or Z reasons, that becomes very much of a blow to the fund manager, including for very genuine impact fund managers.

51:16So we need to tread carefully on this topic, but that's certainly one limitation of the system that we see that is not perfect, was never built to be perfect but was built from day one to only size I'm not too sure it's an English word not too sure it's a most appropriate word but to set in stone the drive and value add of impact investing and to avoid impact washing And I think that, again, if you see, and we touched upon that earlier, if you see the evolution of the market starting from perhaps a handful of 30 fund managers in Europe 10, 15 years ago to perhaps close to 1 ,000 today, it is all the more important that those who claim or call themselves impact fund managers are genuine impact fund managers indeed.

52:14and it's also perhaps just a final word on this particular point i am personally not too convinced on the labeling policy or you know putting a label on the fund allows lps to basically not do their due diligence and have a full comfort around a fund that is an impact fund and we invest in green and i'm convinced i mean mankind being mankind i am personally convinced that such level, there will be opportunity approaches and it will be perverted in some ways. I think there is no way around doing a thorough complete due diligence before making an investment to have the appropriate level of comfort around the impact that will be targeted by the phone manager in question.

52:59Maybe I think there's the GP and the LP perspective and the scorecard discussion and how it fits in. A large reflection as well, as you say, is there's both public LPs, but there's also private LPs. How do we get more of this private LP money into Impact VC? Is scorecard auditing, is that one of the ways of doing it? Are there others? What can really help us get more private LP money into Impact VC? Again, very good question, August. And I think a super particularly sharp one at the moment that I try to answer as best as possible. But yes, on the one hand, I believe this carry mechanism is one element that sets you apart from the crowd.

53:44And so gives your LPs, prospective LPs, a very strong degree of comfort around your investment strategy and your impact strategy. This being said, it's only part of the answer. Because if you ask any impact fund managers, they will all say perhaps their first issue is fundraising. That's perhaps true. And again, an interesting question also to you at BSE, but I think it's true for all venture capital funds in general. Fundraising is difficult. The current macroeconomic, not to mention the current political environment, is such that equity is less attractive than it used to. So if you add in your strategy, not only financial performance in the equities space, but also impact performance, that for a wide variety of LPs would appear as perhaps a risky element.

54:37So fundraising in general is difficult. I think it's particularly the case for impact fund managers. This is why we strive to remain a stable source of funding for the sound development of the market. how do we do to get more private LPs in this market? It's difficult. And if you ask me, we don't see them enough. And we would like private LPs to invest more in impact investment funds, in impact startups altogether. There are other ways to do that. I think the role of public investor in this space is pretty crucial. But one way, we hear a lot about blended finance, about systemic investing. So certainly having risk, let's say asymmetric risk return profiles in funds could be a relevant and interesting way to catalyze more private funding in funds.

55:33That means basically utilizing a source of funding, being public, being perhaps more from a philanthropy side or that would not have the same risk return expectation than private LPs with the sole agenda of tapping into the real sources of funding and tapping into the real source of private capital to flow into impact funds. And private LPs would be incentivized to do so because they have a guarantee that there is some kind of risk protection by some shareholders that would take on the potential losses for funds to be able to get to the target and actually attract and catalyze a wider variety of investors.

56:18So that's one element we're looking into. Then I think that will call very much for the role of foundations, family offices in the space, perhaps that could play that role, provided, of course, you again, that will require the impact thesis to be very strong and very reliable, especially if you are in such a fund profile where not all investors are ranked by ribasso and perhaps private investors, commercial investors invest provided they have certain degree of protection against potential losses incurred by impact funds. This is one way of looking at it or perhaps one solution to attract more private capital in the space.

57:02I think generally also we have to question the fundamentals and basically continue to demonstrate, as we strive to do, that there is this positive correlation between impact performance and financial performance. I'm not saying there is no trade-off between financial performance and impact performance, but I'm saying that what we're seeing, that there is a positive correlation between the two. So provided your agenda as an investor is to maximize impact, preserve your capital, nurture, eventually get also a financial problem on top. Then impact investing seems to be a very relevant strategy to invest in that reconciles both doing good and doing well.

57:48So there are doors that we have not pushed enough that leaves a hope to catalyze more private sources of capital into the space. But it is difficult. Let's be honest and let's face it, the current environment, it is difficult. That's, again, also sort of implies or involves a very strong constants and public investors being constants and still keeping their trust and faith in these strategies so that over time and eventually, potentially long after we retired, you know, proof has been made that this is an impact, this is an asset class or a strategy that makes sense and actually deserves attention, especially more than the others, perhaps more than the others in the current world we live in.

58:39And that reflection of yours around fundraising at the moment being challenging, I think, is one that we'd echo in what we see at BSE, but for impact funds, but also for the general VC market, I think that is challenging at the moment. I saw a statistic the other day that there were more VC funds in market now than there have ever been in terms of the cycle, the growth in VC, but also where we're at in the fundraising cycle and post the sort of froth of a couple of years ago. Funds, how it's coming back to market now and finding there's less capital to compete for and there are more people competing for it.

59:10So there's this historically high point of competition. And I think your points there around the structural innovations that people can make or the fundamental points of evidence people can build around their fundraising, I think is really powerful. But I wonder, apropos of that, what your fundraising tip or tip for Impact VCs would be building on those suggestions and maybe getting into more of the, maybe the fundamentals as well, but also maybe more of the tactics and the positioning and the storytelling and how you think Impact VCs can best do that in the current environment. First of all, you know, what will plead or what will be the most powerful, most convincing element for LP to invest in a fund is your track record as a fund manager, meaning what you've been able in the past to do close as an investment and what kind of performance you've been able to generate across cycles, up cycles, down cycles.

1:00:10I mean, in the last decade, obviously, we have had our fair share of up cycles and down cycles. So the track record is certainly the element that will be decisive to be able to raise. And certainly, this is not a tip, obviously, but this is just to confirm that this is one entry point that will be always looked at with the highest degree of care by any LPs. Then, and I would get back here to the accountability point we discussed earlier, I believe that your capacity towards your LPs to be faithful to your investment thesis and to demonstrate that you have a privilege access to impact companies or to invest in companies that are always after, yes, scaling, scaling potentially a regional or global champion, but scaling it provided you always grow on the back of solving a social or climate issue is a very important element.

1:01:11And in the end, again, your track record will be your most convincing argument always. I think that next to this and to your question, Dougie, there are certain pillars of the social innovation space that needs to be put forward as, you know, sectors that yield very significant or socially climate-intense solution, such as, I don't know, education in the social space, energy in the climate space. Being active on these sectors will, next to a very strong experience and track record, will always prove or provide for a very convincing argument that you can run your investment activity in a very sound slash financially profitable manner next to demonstrate your capacity to generate a very tangible social impact, climate impact.

1:02:01That would be the second element I would mention. The third element I would mention is also, and that's a topic that is particularly close to my heart, is get back to, if you wish, the pioneer self of the early years, meaning impact investors are investors who invest in stuff that the others did not invest in before. And again, that's also a recon, perhaps a bias with my microfinance background. I mean, that's also the most general definition of microfinance you will ever find out there that prevails from the suburbs of London to the suburbs of Dakar is invest or lend to clients to whom nobody else is lending.

1:02:46And I think that remains a very core important element of impact investing because thematics such as the one I was referring to earlier are thematics perhaps around the online arm, around civic tech, around media, around culture that are not invested enough by traditional players, so to say, or by market players, such as impact investors. Those areas are areas that are full of potential in terms of combining potential scale, commercial success, with very tangible, positive social impact. And I sometimes, and again, I don't want to send any generalities that in itself are wrong. You know, a generality cannot be true.

1:03:32But I sometimes wish that impact investors in general get back to this wave of pushing doors that have not been pushed by anyone else before. And perhaps, again, the backpack and the pilgrim stick and go on thematics that nobody invested. Perhaps the model is not proven. Perhaps it's risky, yes. But there is a very strong consensus that such areas can be a very positive, immediate, tangible social climate impact. That's one of the things I would wish to see more going forward. And again, just to close on that question, thematics have always evolved. Again, you were mentioning impact investing 10, 15 years ago.

1:04:21You would see Alps looking at you like wondering if you're not slightly lazy or crazy or lunatic. Back then, the gender thematic was not as big as it is today, as important as it is today. Thematics are evolving. The climate thematics were not 15 years ago. They were already out there, and we know about clean tech, and we know how we develop, etc. But they were not as systematic as in these are urgent sectors we need to invest in if we don't want to end up in a planet that we cannot live in or live on. Always be very mindful that the thematics that are important today will not be the ones that are important tomorrow.

1:05:02Or let's say there will be others next to these important thematics of the day. This would be certainly one of the things I would hope for our ecosystem. Cyril, I actually think that's a perfect way to round it off a little bit because you just gave us some of the key tips for potential new Impact VCs that could start or traditional VCs that could find a new way to impact. So maybe let's round it up there. And I would like to say thank you so much for joining today. It was super interesting to hear everything grow from sort of how do you protect the risk for a new private LP? What are the new trends?

1:05:45What are the new fixes to get to an impact VCs? So yeah. So thank you so much for joining. Thank you, August. Thank you for mentioning again. said it at the beginning. I'm happy I can confirm it at the end. It was a real pleasure. And that's also to your initiatives that are very important for our market and ecosystem as a whole. So thank you very much. Thank you very much, Cyril. Great to speak as always and I appreciate you taking the time. Here's a few words from our beloved sponsor. Impact VC is a global community of VCs accelerating impact within venture. Their purpose is to cultivate a community and resources to unlock venture capital's ability to tackle the world's most pressing challenges.

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