Exit Scenario for Early-Stage Impact Investors

The topic of impactful exits, according to INCO, raises important questions about the long-term sustainability of a project's impact, which is more achievable when acquirers are also committed to impact. More broadly, this issue prompts impact finance stakeholders to develop a model that ensures fairness and benefits all parties involved, avoiding the replication of inequitable power dynamics from traditional finance.

“Impact investors should question, as an ecosystem, the conditions that allow the viability of their ecosystem,” said Jean-Michel Lecuyer, Managing Director at INCO Ventures, “and particularly the way business angels and seed funds can keep a viable financial model – a condition for the existence of the whole impact investing ecosystem.”

INCO & Castalie

Since 2011, INCO has “supported and financed companies that directly respond to social and environmental challenges,” according to their website. INCO’s five funds have managed over €120 million. In 2023, their investees have collectively supported 25,8k jobs, recycled 188k tons of waste and saved 320k tons of eqCO2 from being emitted.

INCO has leveraged their longtime experience to create a useful investment methodology, INCO Ratings, summarised in the figure below.

INCO Ratings in Brief

Notably, INCO’s approach includes additionality; this means their investments generate outcomes that would not have occurred without their intervention. Such was the case with the investment in Castalie.

Castalie is a circular economy company, founded in 2011. They reduce waste by tackling single-use plastic bottles through eco-designed water fountains manufactured in France. Castalie’s fountains have helped companies avoid the use of 340 million plastic bottles.

INCO and Castalie are both French, and the unique conditions of the French impact investing market have influenced their journey together. For example, Castalie is designated as a company of the Social and Solidarity Economy (SSE). As a legal framework, the SSE seeks to reconcile social utility, solidarity, economic performance and shared governance, aiming to enhance social cohesion and create jobs. One pillar of the SSE, adopted in 2014, is to allow access to finance for companies, like Castalie, that have such a social utility. The investment from INCO put this principle into practice.

“We're quite lucky in France,” said Jean Michel Lecuyer, Managing Director at INCO Ventures. “The fact that we have that solidarity base has meant that funds have collected about €3.3 billion euros of stock value in 2023, a flux of €680 millions in 2023, of money to be invested in companies that are labelled like Castalie.”

And yet, Jean Michel was quick to point out a paradox. Speaking of the impact ecosystem, he said, “There is more money, but not necessarily more money to invest in early-stage.”

 

Three stakeholder perspectives 

INCO Ventures was an early-stage investor in Castalie. They invested in in 2015, 2017 and 2019, for a total amount of €1.2 million, via equity and convertible bonds. Castalie had healthy growth, leading to a second investment round in 2020, with investors including Ring Capital,  RAISE Impact, Amundi Finance et Solidarité – and the industrial partner SEB Alliance.

The new investors acquired INCO’s shares at their investment price minus an illiquidity discount. “The Castalie case is quite exceptional in our portfolio,” said Jean Michel. “By now, it's the only case that we were able to sell our investment, our shares, to the new investors, and at quite fair value.” This enabled INCO to return added value to their limited partners and continue investing in other early-stage impact-driven solutions.

To discuss what makes the Castalie case unique, three key stakeholders came together to debrief: Jean Michel from INCO, previously quoted; Florian Peudevin (Private Equity – Impact Investing, Amundi), a current investor; and Thibault Lamarque (Fondateur et Président, Castalie), the investee.

The character of this conversation – open, high-level, systems-oriented – mirrors one of INCO’s central tenets as an organisation: they question established norms. In fact, this is in INCO’s mission statement: “By first questioning the meaning and usefulness of our decision-making, we defend a vision of finance that is sober, anchored in reality and creates value for all: citizens, employees, entrepreneurs and investors.”

One unique part of the Castalie case: the company grew “in phase” with the impact investing market in France. “When you needed early-stage venture, there were people like INCO that were emerging,” Jean Michel remarked to Thibault. “When you needed A or B series, there were people like Amundi or RAISE or Ring. And then maybe when you need the next step, there will be impact investing funds adapted to the next step.”

There is a ‘maybe’ in this statement. But Jean Michel, Florian and Thibault were hopeful that the growth of the impact investing market will eventually provide more options for companies like Castalie. Florian and Thibault pointed out that the presence of reputable investors – such as INCO – attract others via their reputation.

And yet, despite the optimism among the stakeholders in the Castalie exit, there remained an aspect of exits to question and critique. 

 

Critiquing the waterfall

Impact investors are committed to supporting the development of innovative solutions that drive social and environmental change. These projects require substantial funding to scale and enhance their impact, necessitating early-stage investors — from business angels to venture capitalists — willing to take on significant risks in exchange for potential financial and impact returns. As these impact organisations grow, more mature financial actors can take over – such as Amundi and others in the Castalie case.

The issue arises when the impact investment ecosystem replicates the model of preferred shares and waterfall, inherited from traditional venture capital, without re-evaluating fairness. This model can allow later-stage investors to set terms that disadvantage earlier investors. While this may be justifiable if a company faces difficulties and later investors assume similar or even higher risks as the early ones, it can be inequitable when risks have diminished since the first round.

Alternative approaches, such as equality of treatment of the successive rounds of investors in the second stage of the waterfall (reimbursement of all amounts invested, in due proportion of those amounts), should be considered, according to INCO. Another acceptable solution: investors of a new financing round buy previous investors' shares (as occurred in the Castalie case). These practices can help avoid unfair financial distributions linked to the new waterfall, promoting a healthier system that incentivises early-stage investors to support the development of sustainable solutions.

Florian, as a later investor with Amundi, broadened the critique of the waterfall model. That model, he said, “works very well with traditional private equity companies. But when you come into an environment which is focused on financing impact investing and innovative companies, you can see that you will have a significant challenge to address... Compared to the US or the UK, we are still missing some early-stage money in our unlisted financing environment. We need to attract more.”

Conclusion

People who become impact investors often had previous lives in mainstream finance. They are, therefore, keenly aware of the differences between what works in mainstream and what works for impact. If impact investors continue to take their cues from mainstream finance at the exit stage, they risk falling victim to a model with acute shortcomings for early-stage investors. And if early-stage investors were to become critically disincentivised, the impact ecosystem would suffer in myriad ways.

A fairer waterfall system could be settled when later investors invest, or later investors could consider buying out earlier investors’ shares – including a significant illiquidity discount. Both solutions are difficult to implement at the moment, said stakeholders from INCO, but not impossible: the Castalie case proves it can be done. The outcome, for INCO, is the ability to keep investing in other impactful companies.