Can Venture Capital Be Optimized for Happiness?

Venture capitalists have profited handsomely from innovative ventures, but value hasn’t always been shared with other stakeholders. What if we developed a new model for measuring the impact of investments?

Venture capital (VC) has helped foster innovation that has changed how billions of people live, work, and experience the world around them. Those who have had significant involvement in the development and funding of these ventures have profited handsomely. Yet this value has not been shared equally by all stakeholders. VC firms (and private equity in general) aim to maximize the monetizable value of their investments, often at the expense of affected stakeholders who aren’t legal parties to the deal. Indeed, industry research acknowledges that the value created through VC investments does not accrue proportionately to all parties involved in its creation; instead, most of the pecuniary value benefits the owners of equity. This often leaves those who experience the greatest impacts of the venture (employees, customers, suppliers, communities, competitors, and the environment) with the short end of the stick.

It doesn’t need to be this way. Both investment and business communities increasingly recognize the need to design operations to create and capture value for all stakeholders, except status quo competitors who stand between customers and newer, better solutions. Ultra-high net worth, limited partners of private equity and venture capital firms are in a unique position to lead this change, as they have a comparatively high degree of freedom over how and where to direct their investments. If they wanted to direct investments based on the value created for all stakeholders as well as the financial return of an investment, they could. This combination of social and financial returns, or “blended value,” was adopted initially by actors in the venture philanthropy and impact investing spaces. More recently it has become more widespread across the institutional investor community, as they increasingly recognize we cannot continue to focus solely on financial value creation at the expense of people and the planet.

As the recognition of blended value has increased, investors have sought to analyze investment opportunities based on their potential to generate integrated social and financial returns. Many different approaches, such as Towards the Efficient Impact Frontier
and the Value Balancing Alliance Methodology, have emerged to analyze environmental and social impacts and to consider their integration with financial performance. These have been developed alongside accounting standards that address environmental and social factors, such as those of the International Sustainability Standards Board. While useful, they are problematic as they generally frame environmental and social as material risks to company performance rather than as potentially self-defeating risks to society and the planet. Unless there is a coherent purpose to the measurement approach, related to both improving the well-being of all the affected parties and to company financial health, ESG measures do not necessarily address the systemic risks that business and investment pose to human well-being.

Through an introduction from Jed Emerson, the impact measurement, management, and strategy firm SVT Group (where three of the coauthors work) met Happiness Capital, a Hong Kong-based venture capital firm whose mission is to make the world a happier place by investing in startups and VC funds that are committed to the same mission as theirs (and where another one of the coauthors works). Happiness Capital wanted to develop a metric that measured how their investments “create happiness.”

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SVT set out to develop a framework to conceptualize, assess, and compare investment opportunities for Happiness Capital, who seek to maximize the effect of their investments on well-being, while also generating healthy financial returns. We’ve dubbed this the Happiness Return Framework. Our approach can be used by a wide range of venture capital firms, and all forms of private equity firms, as it is a replicable, analytically manageable model that can be used to begin to systematically incorporate the happiness and well-being of all stakeholders into investment decisions.

The Happiness Return Framework

To assess changes in happiness, we needed to define it. We define happiness as the well-being of an individual, which consists of two perspectives: the conditions that affect someone’s happiness and how they experience
these conditions. We define the conditions for well-being using the OECD’s Better Life Index, which maps responses on 11 topics like safety, environment, and life satisfaction in addition to income and education, and the experiences through Seligman’s PERMA Framework (positive emotion, engagement, relationships, meaning, and accomplishment). Both perspectives may be measured in objective (by observers) and subjective (by the people being affected) terms. Importantly, the link between climate change and individual well-being is becoming increasingly better understood—with climate change increasingly linked to anxiety. We also intend for the Happiness Returns Framework to inform practical decisions which require a level of specificity. Therefore, we also consider the impacts of a venture on the nine planetary boundaries, the key life support processes of the natural ecosystem that, when overexploited, increase the risk of large-scale climate impacts or disasters which ultimately have a downstream impact at the individual level. This is consistent with the parameters set in the Donut Economics model—which posits that in order for humanity to have a safe and just space to thrive, a social foundation and an ecological ceiling are needed.

The assessment of the combination of all the factors mentioned above is called the Happiness Return Framework. When complemented by traditional financial assessment, the Happiness Return Framework allows for the creation of integrated return; yielding concrete information which is used by Happiness Capital to inform its investment decisions. This approach is consistent with those developed by others in the field (e.g. Impact Frontiers and Engine No.1) who have pioneered new ways to integrate impact management with financial management for direct investors through their approaches. Like Impact Frontiers, Happiness Capital seeks to open source its Happiness Return methodology to spur the adoption of more comprehensive accounting for the true financial and extra-financial value of venture capital.

Why This Model Is Exciting

Our model offers the ability to adapt the assessment to multiple different types of individual ventures and produce comparable scores grounded in the experiences of groups of people who are affected by venture investment activity. This allows the fund to make better-informed decisions regarding where to invest to achieve positive effects on societal well-being.

Our model also uses existing data where possible (i.e. the Better Life Index Self-Assessment), combined with targeted information provided directly by the company’s management team, and publicly available sector-based research. When the opportunity exists to work closely with a portfolio company and undertake a deep dive survey of key stakeholders, we have worked with 60 Decibels
to design and implement a survey to test and validate our assessment. To date, these have been done for roughly 10 percent of portfolio companies. They are designed to provide actionable information for the investor and the portfolio company in a way that minimizes the burden on ventures and other stakeholder groups. This makes the experience of assessment easier and balances the value taken by the investor and received by the portfolio company or fund that provides it.

Finally, the most exciting part of our framework is that it provides a global assessment of a venture’s effect on all stakeholders who are significantly impacted by its activities. This then allows for a holistic view of the relationship between the well-being of those affected by a portfolio company’s activities and investments made into that company.

Use of the Model to Date

Currently, we have analyzed 46 ventures and 35 funds. We have done this using data from a combination of interviews with founders/CEOs, the aforementioned deep-dive survey of stakeholders, materials and data provided to the fund by the company and desktop research by SVT. Potential scores are assigned based on defined scales, to arrive at an overall score that falls between 0.0 and 2.0 (where 1.0 equals no change in well-being or happiness). To date, Happiness Capital uses the portfolio-level and company-specific views of the projected future or estimated current impact on the well-being of their investments across their investment decision-making process: during due diligence, through the investment process (support, reinvest, or divest), and to be accountable to their sole limited partner.

Dashboards and the supporting data provide granular detail about the impact of a venture across the relevant domains of well-being.

As an example of the approach, for one venture with an app to help small-scale farmers in the sub-continent diagnose crop issues and improve yields, we modelled the venture’s impact thesis using our framework. We were able to then test how farmers used the app and what changes they experienced.

Early Insights

One of the most important early insights delivered by the Happiness Return Framework is the ability of Happiness Capital to view their impacts on happiness across all sectors in which they invest—and correlate this to their measure of financial return. Drilling deeper into each sector can show which ventures may affect happiness the most and allow Happiness Capital to share insights with others, whether other investors or related stakeholders.

An important lesson has been to focus on relative scores across ventures in the same sector (such as alternative proteins or different solutions to the problem of space junk), not the absolute score of any single venture. Being consistent in how the model is scored across ventures is key, and it’s easier to reduce the risk that an analyst’s subjective interpretation will introduce variability into the scoring within sectors.

The assessment also informs portfolio decisions (i.e. company selection, additional investment, divestment, and exit) and can surface opportunities and risks affecting the well-being of portfolio companies’ stakeholders—which may affect a portfolio company’s financial performance.

For example, a decision was made not to proceed with an investment in a fintech startup even though it was expected to generate a favorable financial return. The startup allowed customers to borrow against earned but unpaid income, integrated into the payroll system of employers. The Happiness Return assessment considered a broad range of potential customer groups, including how individuals at different levels of financial stress could be impacted in negative ways and if the startup was considering these issues. The framework can also support systematic consideration of the risk that an acquirer may undermine the well-being of stakeholder groups when considering exits.

By using the Happiness Return Framework, the investor also gains insight within a sector as to which new ventures are likely to be most successful, on what terms, and why. For example, for various alternative protein sources, how are they constituted into nutritious and tasty food and whose well-being is affected across that value chain? Across sectors, the investor may contemplate scale versus depth of impact versus timeframe: for example, do health innovations take longer to realize full impact than food investments?

Significant work remains to understand the relationship between model outputs, positive or negative impact, and financial returns over time. As the analysis has been done by a small team, there is a risk that scores may be influenced by the inherent bias or experiences of the scorer in a way that masks the underlying reality whether intentionally or unintentionally. We have sought to mitigate this through instituting a review process which allows the rater to discuss their approach and understanding, to reach team alignment on the final score. Alternative protein is a good example of ventures exploring new protein sources from plants, insects, microbes, cells, and bioengineering—all of which may raise different concerns based on an individual’s personal beliefs, preferences, or philosophy.

This framework is still a work in progress as we refine the model, its governance, how it is used, and its outputs. We believe analyzing results at the sector level, with a consistent base model and some correlation across the stakeholder groups assessed and the definitions of scale and type of impact is a first step toward our goal of offering investors a greater understanding of the various aspects of value creation in which they are engaged. Starting at the sector level is important because it allows us to understand whether the potential investment decision is better or worse than the average venture in the sector.

Where We Think This Could Lead

Our ultimate goal is that the thinking and framework behind our model becomes open-source knowledge that is broadly used by investors, regardless of the size of the assets under management.

We have been asked why this sort of approach has not already been developed and adopted. A few observations:

Our hope is that this approach inspires others to advance their own approaches to investment analysis that allow users to weigh the diverse ways their investments affect the conditions and experiences that they, and their societies, care most about.

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Read more stories by James Dudfield, Sara Olsen, Aaron Mallett, Jed Emerson & Eric Ng.


Impact Investing

James Dudfield
James Dudfield is a partner at SVT Group, an impact measurement, management and strategy firm that works with clients to understand and optimize their social and environmental impact.

Sara Olsen
Sara Olsen founded SVT Group in 2001. She is a board member of Social Value International and Social Value US; has taught impact management across the US; and authored several publications on impact management.

Aaron Mallett
Aaron Mallett is an impact strategy consultant at SVT Group, where he specializes in Social Return on Investment (SROI) analysis, supporting analysis projects across the globe.

Jed Emerson
Jed Emerson is Chief Impact Officer for Tiedemann Advisors/AlTi. He was founding director of Larkin Street Services and REDF (a venture philanthropy investing exclusively in social enterprises employing and empowering people overcoming barriers to work).

Eric Ng
Eric Ng oversees Happiness Capital. He is also a Senior VP at the LKK Health Products Group, of which Happiness Capital is a member company.