In our discussions with investors, many identified the choice of corporate governance as a significant factor in how companies that prioritise positive social and environmental impact might execute their strategy. The ability of innovative company structures to attract investment interest could therefore help guide circular economy entrepreneurs at the earliest stages of business planning.

One well-known type of AOE employs ‘steward ownership’. This structure often involves the creation of a trust or foundation that oversees the company to ensure that positive impact is prioritised. Well known firms such as pharmaceuticals giant Novo Nordisk (the most valuable company in Europe) and outdoor clothing company Patagonia are based on this model.

Steward ownership has two key principles:

• Self-determination - Control of the company is held by stewards who are directly connected to the company’s operations and not by distant absentee owners.
  

• Purpose as the key driver - Profits are generated to serve the purpose and mission of the company.
  

Steward ownership-type structures lend themselves well to circular economy ventures by allowing companies to preserve their purpose-orientated focus and give this priority over short-term profit. It navigates the issue of founders recognising their need for outside capital but having concerns over retaining control over how their business operates.

One potential obstacle is the time and cost involved in establishing a trust or foundation. Making this process more streamlined could open up the steward ownership model to a larger number of aspiring circular economy enterprise founders. 

Benefit corporations allow founders, directors and managers to pursue a public benefit as well as create shareholder value. This structure broadens out from the traditional strict fiduciary duty of the management to act solely to maximise shareholder value.  

The social or environmental mission is central to the company charter and there is a requirement for an annual benefit report to be produced to demonstrate that the company is acting in line with its mission.

This structure offers access to the full range of financing that traditional companies enjoy. A number of benefit corporations, for example ethical food company Vital Farms, are now listed on the US stock exchange. 

There are many other alternative structures that circular economy companies could consider. The key takeaway is that having purpose as a primary business driver need not be a barrier to accessing funding or achieving growth.

However, for AOEs to develop a significant foothold will require investor perceptions to shift. Many investors will be uncomfortable with the lack of control or influence offered to them under some of these governance structures.

Investors need to be shown how prioritising purpose can offer potential additional benefits from an investment perspective. This systemic change will take time, but as impact investor firms gain greater voice and influence they can help bring the wider investment community into conversations about AOEs, valuing both financial and non-financial returns, and the wider topic of business governance.

The investor landscape for circular economy companies is not materially different from that which exists for other start-ups and many of the challenges are similar.

Minimum investment thresholds set by VC funds were often in excess of the funding needed by the CIC cohort companies given their business activities and stages of development.

Many VC funds have a preference for tech-enabled enterprises, which they perceive as more capable of scaling-up at speed, with performance ambitions often set at 5-10x returns over the duration of the fund, which is commonly five to seven years. Enterprises with complex physical supply chains and unproven business models – such as many of the early-stage, textile-focused circular economy companies in the CIC cohort – can therefore face additional hurdles in seeking VC funding. Given the opportunities and positive impact potential that exists within the circular economy space, VC funds should look to take a more nuanced approach, which may include a willingness to accept a longer payback period. As discussed above in relation to AOEs, investors assessing enterprises for potential financial returns should be encouraged to do this through a lens which also recognises and values positive non-financial outcomes.

Impact funds mandates that require delivery of both financial and non-financial outcomes clearly provide an opportunity for more flexibility and may permit the consideration of investments that would not traditionally meet the requirements of a VC fund. CIC has seen this in action with the CIC cohort company Martan, which received financing from an impact-orientated funds, following unsuccessful engagement with VC investors.

Five of the 10 CIC cohort enterprises had secured funding from the angel investor community – individuals who share the vision and passion of the company founder and often seek a return that is not just financial.

However, accessing angel investor communities can be challenging. They are diffuse, which can make them difficult to identify and access. They may also have a narrow range of investment interests that are specific to individual industries or sectors.

The support angel investors can provide is highly varied, but to give a few examples: an angel investor focused on female entrepreneurs can give insight into particular gender-based challenges, an angel investor with a background in retail could assist with ‘go-to-market’ strategies for a consumer-facing business, and an angel investor working in the fashion industry could provide valuable input on design. There are angel investor groups in Amsterdam and more broadly in the Netherlands, including the Netherlands Angel Investment Network and Operator Exchange.

The CIC cohort companies seeking funds were keen to find an investor who could be more than just a source of funds. Both Martan and Mended found angels who were able to help with specific aspects of business development. From the investors’ side, this level of engagement helped them to better monitor company performance in ‘real-time’ to ensure returns, both financial and non-financial, were on track to be delivered.

Some of the CIC cohort were seeking smaller sums of below €50,000, making a first funding round targeting family and friends investors a more appropriate initial strategy.

'Family and friends investors' usually refers to a small group of individuals, often as few as four or five, who each put in a ‘modest’ sum (in investment market terms) to provide a start-up with some capital that can help carry it through to a more substantial funding round at a later stage. This source of investment can provide essential ‘bridging finance’ for companies at a very early stage of development.

Discussions with several funds revealed a general belief that the pool of investment opportunities fully committed to circularity was limited in number and scale. In some cases, this had caused fund managers to widen their remit to a broader based ambition around impact.

Issues around investor focus are multi-faceted. For example, one investor that we spoke with is focused on three distinct areas in the textile value chain to help drive the circular economy: use, materials, and technology. While the CIC cohort companies are well aligned thematically, the investor’s remit is the growth equity part of the capital formation journey, so, at the time of assessment, the companies were viewed as being too immature. As the CIC cohort develops, more sources of financing might open up from this type of investor, underscoring the importance of maintaining connections and the benefits of a robust circular innovation ecosystem.

Another investor described their investment process as having a strong commitment to circular economy opportunities with ventures that can show exponential growth. However, they conceded that this had been proving a hard requirement to meet for most companies.

One family office with a heritage in textiles stated that they looked at potential opportunities in this area even if the size of investment would normally be too small for them to consider. This suggests that, similar to angel investors, finding a source of financing that has a connection to the companies’ activities can be helpful.

The policy and regulatory framework for circular economy issues is complex, varies between different locations, and is significantly better developed for some R-strategies versus others. For example, legislation governing recycling is well established across many countries. Municipal authorities in some locations have outsourced refuse collection to commercial businesses that have put recycling programmes in place, with different materials to be separated by the consumer before collection. However, this process of separation by residents is generally not mandated, it is merely encouraged.

For other R-strategies, however, there is little-to-no guidance for companies or consumers. Government policies will not change consumer behaviour on their own, but they can help raise awareness and encourage the wider adoption of circular economy practices. Policy changes, allied to shifts in consumer behaviour and expectations, can help drive demand for businesses to implement circular economy business models. This may ultimately lead to a ‘virtuous cycle’ of change that provides a more attractive circular economy investment landscape for investors of all kinds and grows circular innovation activity among the business community across all sectors of the economy.

Systemic change, supported or encouraged by governmental policy intervention, is required to create a framework that will encourage greater business development in the circular economy and engage investors in a deeper understanding and commitment to the area. For example, the Dutch government significantly contributes to nurturing the general start-up environment by offering financial assistance, tax incentives, and other benefits to entrepreneurs.

Policy implementation is just a first step in systemic change. For these policies to have a meaningful impact will require a mindset shift among business owners, investors, and consumers. Explicit targets or mandatory regulation around R-strategies is one route, but there is also evidence that suggests creating conditions that encourage or ‘nudge’ consumers and businesses to change their behavioural patterns is highly effective. A combination of these two pathways to change may prove the most successful approach.

CIC cohort company combination of education and competition to raise awareness among children about the environmental impacts of fast fashion is one example of how the nudge principle can be creatively applied.

By providing a framework for understanding the adverse impacts of fast fashion and a ‘throwaway culture’, and using gamification to encourage students to help reverse these trends, the programme is changing wasteful behaviours by making it fun. Interactions between the young participants and their parents is an added layer of spreading the environmental messages. The programme has proved very successful. It has been widely adopted across the Netherlands and has begun expanding into other countries.

The first step is to establish clear targets that businesses can understand and that are realistic with respect to their development stage. This target setting can be an iterative process and might involve creating a series of intermediate goals on the path towards achieving a more ambitious one. 

There are likely to be several outcomes that an investor is seeking from a company, and these should also be clearly established between the parties at an early stage. Understanding how these outcomes might interlink or influence each other is crucial. For example, changing the materials used in the production process might result in lower transport costs and carbon emissions. There must be a willingness to employ dynamic prioritisation as circumstances change. Investors and businesses should clarify if certain business activities or operations are linked to particular outcomes. 

It is also important to consider how associated parties and other stakeholders could help or hinder the process of achieving the desired outcomes – for example, the impact of Scope 3 emissions related to a company’s supply chain. A report sponsored by the Dutch government explores some of the issues and solutions in addressing Scope 3, but similar issues exist in many other areas of impact measurement.

In addition to clearly identifying and delineating outcomes, companies and investors must also grapple with the thorny issue of how to measure impact. This must include consideration of what is possible, what is practical, and what is meaningful. Cost, resource availability (including personnel and time), materiality, and assessment are just some of the factors that feed into these considerations. 

Cost and capability are particularly pertinent in the context of start-up companies. For example, one obvious metric is reducing carbon emissions through the setting of time-based targets. However, this requires a company to establish its baseline emissions, implement actions that will result in reductions, and regularly measure progress against targets.

To do this in a credible way involves, at a minimum, robust data collection and analysis and a carbon audit by an outside organisation. This will be prohibitively burdensome for many start-ups, which are generally operating with limited resources, and need to focus their time and attention on business development. Investors and enterprises should work together to identify realistic impact performance indicators and understand that these can evolve alongside business growth.

Investors and companies should also establish how the various impact metrics will be measured – for example, whether to adopt lagging or leading metrics or a combination of the two. 

CIC cohort enterprise Martan notes in various company materials that it uses 98% less water to produce its textiles compared with conventional processes. One alternative to comparing its performance to an industry-wide average would be to state its own water use per unit at the commencement of its operations and then compare its water use per unit over time to this baseline. Each approach has its merits and limitations, but the key is for those who wish to assess these performance indicators to understand how and why they have been adopted and what they show about the firm’s impact and performance.

While investors are generally more comfortable with quantitative metrics, the value of qualitative metrics should not be discounted. Provided a rigorous collection procedure is adopted, surveys or customer feedback channels to gather opinions on company operations or improvement initiatives can form a useful part of impact assessments. Such data can help to show investors and the company’s wider group of stakeholders, such as business partners and customers, that impact is being achieved. 

The use of technology for data collection and analysis, such as emissions measurement software, can facilitate better reporting, particularly for start-ups with limited resources and time. Impact measurement and reporting-related incentives or subsidies could also help make the process easier and more widespread. 

At a higher level, accelerating efforts to harmonise impact-related metrics, standards, and guidance within and across industry sectors and geographical boundaries will play a crucial part in encouraging greater private capital flows into circular economy and other sustainability-focused enterprises.

During the course of our research, one investor commented,
‍
‍“investors committed to advancing the circular economy recognise the critical role of precise impact measurement in investment decisions.

Setting clear, quantitative impact goals and periodically assessing these through key metrics, not only enables us to understand the immediate benefits, but also to align our financial objectives with sustainable practices moving forward.

This approach aids in decision-making and ensures that our investments contribute in a tangible way to environmental and social goals, which can enhance our portfolio's value and appeal to a broad range of end-investors.”

With a robust process for identifying outcomes, assessing initiatives designed to achieve these outcomes with the aim of continuously improving performance, and measuring impact using clear metrics, investors can evaluate whether and to what extent the funds they have deployed are resulting in positive change. 

A common key issue for investors is whether making impact the primary business objective will act as a drag on financial returns and, if this proves to be the case, the degree to which they are willing to compromise on financial performance in return for positive environmental and social impact. 

There is a large amount of academic research on the relationship between these two variables.

There is also useful research available on the performance of impact funds versus conventional VC funds and public markets. One recent study found that impact funds were less sensitive – in investment terms, had a lower beta – than VC funds to movements in public markets. The study also found that although impact funds modestly underperformed public markets over the 20-year analysis period, they almost exactly matched the performance of an appropriately comparable group of VC funds. In simple terms, the impact funds delivered a similar investment performance with a lower risk (volatility) profile than the VC funds.

While investors and fund managers will each have their own risk, return, and impact requirements, an important takeaway from this research is that prioritising impact does not have to come at the cost of lower financial returns. As the research suggests, it could even potentially have an overall positive effect on financial performance, particularly over the longer term. 

Inevitably, there will be cases where the desire to have a highly positive impact will see circular economy enterprises willing to accept a lower level of financial return (e.g., using higher cost materials or processing techniques to minimise their carbon footprint). Over time, wider awareness and understanding of the benefits and necessity of the circular economy should help grow the pool of investors that are willing to consider investing on this basis.

For now, however, this group of enterprises may need to step away from the VC-backed approach to funding, at least in part, and make use of grants or philanthropic capital as a cornerstone. There are also growing opportunities to pursue a ‘third way’ through blended finance and other innovative funding structures that bring together public and private sector capital.

Innovations in funding structures and choice of business models are well represented in the sustainability space.