Venture capital investors: Prioritising sustainable growth over scale-ability, By Okupe, Beinisch, et al.
This is especially true for investment in “sustainable” and “circular” businesses.
Scale and Sustainable Development
One of the greatest ambitions of the Sustainable Development Goals is to mobilise private sector finance to meet its seventeen social and environmental targets. The theory is that it is only through the private sector that the quantum of investment can be available to create scale-able solutions to address global social and environmental challenges.
Indeed, scale is a fundamental pillar across the investment chain. For venture capital investors, scale, in terms of the capacity to multiply revenues, is a reward for risk-taking on young and uncertain enterprises. For institutional investors, scale, in terms of ticket size, is the most efficient way to deploy capital. Businesses that are designed with the capacity to scale are therefore better suited to create opportunities for investors and efficiencies in the market.
Investment aside, we believe that businesses that scale add value to the economy and society for other important reasons. For example, business scale improves the potential for partnerships because it provides a platform for the development and testing of new ideas that can deliver value to customers in novel ways. Industry giants are the darlings of university research centres, not only because of their potential as generous patrons but also because they can provide distribution channels for commercialising experimental solutions.
The digital revolution has furthermore demonstrated how scale improves the diffusion of knowledge and access to technical solutions. Emerging industries such as ed-tech, tele-medicine and de-centralised manufacturing are transforming how people access information and develop their technical skills. It is only through scale that these technologies can be more accessible to communities.
Scale Cannot Be An Independent Optic
However, we argue that irrespective of the fundamental benefits of business scale-ability, it is not appropriate and it is even dangerous to use this optic alone to evaluate the potential of emerging businesses, especially those which are aiming to deliver value in a way that is compatible with the Sustainable Development Goals.
We argue that on its own, scale-ability is a poor criterion for assessing the quality and potential of start-ups which are building “sustainable” and “circular” businesses; that is businesses that seek to create value while also delivering on the SDGs. There are three key reasons for this.
First, the focus on scale obscures the need to focus on sustainable growth and the development of capacity of emerging businesses. These skills are foundational to scaling but are often overlooked. Even in tech, where scale through users is an important factor determining the viability of a business model, we have seen many recent examples of corporate failure due to structural weakness, lack of controls and the lack of management development of young entrepreneurs. The collapse of FTX and other bitcoin operators is a recent and memorable example that has led to the destruction of billions of dollars of value, almost overnight.
In an African context, specifically that of Nigeria, we argue that administrative and managerial capacity is even more fundamental than business scale-ability, compared to other contexts, because talent development is a substantial issue. For example, a skills-gap assessment carried out by UNIDO in 2016, found that the productivity of the Nigerian workforce trailed that of South Africa by a factor of five. These findings are corroborated by employer surveys carried out by Equinix in the IT sector, which found 58% of employers citing the lack of skilled personnel as a threat to their businesses. Without relevant skills development, companies are not in a position to scale in a way that it can be sustained, no matter how shiny and promising their business model is.
Secondly, the focus on scale at early stages of product and business development distracts from producing products that are genuinely adding value to customers. From a circular economy perspective, consumerism has produced negative consequences, with climate change related events being the most threatening. While it is true that we require large-scale game-changing solutions to address these challenges, in many cases the game must be changed in the other direction. In this respect, scaling for scaling’s sake does not necessarily produce the types of value that lead to better social and economic outcomes. For example, Candy Crush can scale but we must reflect genuinely on its value to society.
Finally, many business models cannot scale, even though they produce value. In the context of circular economy business models, many, such as industry symbiosis, are by definition more closed. Sustainable tourism is another example, especially because for tourism to be sustainable, visitor traffic must not compromise nature or society. These are examples of important areas of investment that deliver value and potentially growth but would not pass through scale-ability hurdles.
Investors Must Integrate Value and Consider Talent Development In their Assessment Models
It is urgent that sustainable start-ups, particularly those that are working to produce value in ways that reduce resources receive funding to develop, but we argue that scale-ability should be not considered as a priority factor to consider whether an emerging enterprise is ready for funding. We argue that while scale-ability is important, it is essential to also evaluate whether founders are open and willing to develop their selves and others and that they are oriented towards creating value for customers and stakeholders. We furthermore believe investment approaches that recognise that linear and long-term growth for some business models should be encouraged. We argue this focus will produce stronger companies and more stable returns for investors in the long run. The key is for investors to have the confidence in new approaches.