Green Startups Win Funding But Then Underperform

The Green Premium That Punishes Investors

Here is a number that should make venture capitalists wince: 28 percent. That is how much more money a startup can raise if it presents itself as environmentally and socially responsible. Here is the number that should make them actually worried: minus 16 percent. That is the annual hit to investor returns those same startups deliver after the funding arrives.

This is not a story about greenwashing, at least not in the simple sense. It is a story about how the financial markets for sustainable entrepreneurship have developed a strange, almost perverse logic. Investors pay a premium for virtue, and then they get punished for it. The paper that documents this paradox, "Financing sustainable entrepreneurship: ESG measurement, valuation, and performance" by Sasan Mansouri and Paul P. Momtaz in the Journal of Business Venturing (Mansouri & Momtaz, 2022), is not an attack on sustainability. It is a diagnosis of a market failure. And it suggests that the way we currently fund green startups might be making them less successful, not more.

The Machine That Reads Your Soul

Before Mansouri and Momtaz could measure the financial consequences of sustainability, they had to solve a harder problem: how do you measure a startup's environmental and social commitments when it has no track record, no annual reports, and maybe not even a product?

Public companies have standardized ESG scores. Startups have white papers, pitch decks, and tweets. The researchers built a machine learning model that could read the textual content of Initial Coin Offering (ICO) whitepapers and assign them an ESG score. They analyzed 1,128 blockchain startups that raised money through token sales between 2016 and 2021. This is an unusual sample, but it is a useful one. ICOs are transparent by design. Every whitepaper, every token price, every transaction is recorded on a public ledger. You can watch the money move.

The model looked for signals of genuine sustainability orientation: specific language about environmental impact, governance structures, social mission. It was not looking for green buzzwords. It was looking for coherence, specificity, and commitment. A startup that said "we will plant trees" scored lower than one that said "we will use a proof-of-stake consensus mechanism that reduces energy consumption by 99 percent."

The result was a dataset that allowed the authors to do something rare in startup research: compare the stated values of a young company with its actual financial performance, all in a setting where the data is public and verifiable.

The 28 Percent Premium

Here is the finding that should make every sustainable entrepreneur pause. For every one standard deviation improvement in a startup's ESG score, the amount of money it raised increased by 28 percent. This is not a small effect. It is the difference between raising $5 million and raising $6.4 million, all else equal.

The mechanism is straightforward and human. Investors want to feel good about where their money goes. They want to tell their limited partners, their friends, and themselves that they are funding the future, not just extracting profits. A strong sustainability narrative signals that a startup is run by people who think long term, who care about stakeholders beyond shareholders, who will not destroy the planet for a quick exit.

But here is the problem with that logic. The same signal that makes a startup attractive to investors also makes it less likely to generate returns. The authors found that improving ESG scores by one standard deviation was associated with a 16 percent decrease in investors' abnormal returns per post-funding year. Abnormal returns are the returns above what you would expect from a comparable investment. These startups are not just underperforming the market. They are underperforming their own potential.

Why Virtue Does Not Scale

The obvious explanation is that sustainable startups are simply worse at business. They spend money on solar panels instead of salespeople. They hire diversity officers instead of engineers. They prioritize stakeholder meetings over product development.

Mansouri and Momtaz do not find strong evidence for this story. The underperformance persists even after controlling for industry, team quality, and market conditions. It is not that green startups are run by incompetent people. It is that the incentives created by the funding process itself are misaligned.

Think about what happens when a startup gets a 28 percent premium for its sustainability narrative. The founders now have more money than they would have otherwise. More money means less discipline. It means they can hire faster, spend more on marketing, and delay the painful decisions that force a startup to find product-market fit. It also means they face less pressure from investors, because those investors already feel good about the mission. Nobody wants to be the person who yells at the climate activist about burn rate.

The result is a soft bigotry of low expectations. Sustainable startups are given more rope, and they hang themselves with it.

The Crowdfunding Paradox

The blockchain setting of this study is important because it isolates a specific mechanism: retail investors. ICOs are crowdfunding events. The investors are not sophisticated venture capitalists with board seats and liquidation preferences. They are individuals, often motivated by ideology as much as returns.

This is exactly the kind of investor who is most susceptible to the sustainability premium. They want to believe. They do not ask hard questions about unit economics. They read a whitepaper about carbon credits and blockchain transparency and think, "this is the future." Then they buy tokens, the price goes up briefly, and then it crashes.

Mansouri and Momtaz found that the negative effect of ESG on performance was strongest in startups that raised money from ideologically motivated investors. When the funding came from investors who were less concerned with mission, the performance penalty disappeared. This is a crucial detail. It suggests that the problem is not sustainability itself. The problem is the type of capital that sustainability attracts.

Venture capital is supposed to be smart money. It comes with oversight, expertise, and a willingness to fire the founder. Crowdfunding is dumb money. It comes with enthusiasm and no strings attached. When you give enthusiastic but inexperienced investors a reason to feel good about a risky bet, they stop asking whether the bet makes financial sense.

What the Study Does Not Prove

This is where we need to be careful. The Mansouri and Momtaz paper is about blockchain startups in a specific time period. ICOs are a weird corner of finance. They attracted a lot of fraud, a lot of hype, and a lot of investors who did not understand what they were buying. It is possible that the results do not generalize to traditional venture capital, to later stage companies, or to more established industries.

The authors are aware of this. They note that their sample is "large and representative of the ICO market" but that "caution is warranted in extrapolating the results to other settings." This is academic code for "we think this is a real phenomenon, but we need more data to be sure."

There is also a question of measurement. The machine learning model that assigns ESG scores is clever, but it is not perfect. It might be picking up on something other than genuine sustainability. A startup that writes a very detailed whitepaper about environmental impact might also be a startup that spends too much time on whitepapers and not enough on building a product. The ESG score might be a proxy for something else entirely: naivete, overpromising, or simply being too early.

And then there is the question of time horizon. The study measures performance over a few years. Sustainable businesses might take longer to mature. A solar energy startup that underperforms in year two might dominate in year ten. The authors cannot test this because the data does not go back far enough. It is possible that the 16 percent penalty is a short term cost that pays off later.

But here is the thing. Venture capital is not patient. Most funds have a ten year life. If a startup underperforms for the first five years, it might not survive to see the payoff. The 16 percent penalty is not a theoretical problem. It is a real drag on returns that makes it harder for sustainable startups to raise their next round, hire talent, or attract acquirers.

The Signal Problem

There is a deeper issue here, and it is about signaling. When a startup emphasizes its sustainability credentials, it is sending a signal to investors. But that signal is ambiguous. It could mean "we care about the planet and we will build a lasting company." It could also mean "we are not confident in our financial projections, so we are compensating with a story."

Investors are not stupid. They know that sustainability is a popular narrative. They also know that many startups use it as a crutch. The result is a kind of arms race. Every startup claims to be sustainable. The signal becomes noise. Investors stop believing any of it. But they still pay the premium, because they are afraid of missing out on the one startup that is actually different.

This is the classic market for lemons problem, first described by economist George Akerlof. When buyers cannot distinguish between high quality and low quality goods, they assume the worst and pay less. But in the sustainable startup market, the opposite is happening. Buyers cannot distinguish between genuine sustainability and greenwashing, so they assume the best and pay more. This is a market for peaches, not lemons. And it is just as dysfunctional.

The 28 percent premium is not a reward for virtue. It is a tax on gullibility.

What This Actually Means

• ▸If you are a sustainable startup founder, be wary of easy money. A 28 percent premium sounds great, but it comes with strings attached. That extra capital might make you complacent. It might attract investors who will not hold you accountable. Consider taking less money from more sophisticated investors who will ask hard questions about your business model, not just your mission.

• ▸If you are an investor, adjust your valuation models for sustainability. The standard approach is to add a premium for ESG. Mansouri and Momtaz suggest you should subtract a discount. Sustainable startups are not worth more. They are worth less, at least in the short term. If you are going to pay a premium, demand a corresponding amount of board control or downside protection.

• ▸The crowdfunding model for sustainable startups is broken. Retail investors are not equipped to evaluate the tradeoffs between mission and margin. They overpay for virtue and underperform as a result. If you want to fund sustainable entrepreneurship, do it through vehicles that align incentives: venture debt, revenue based financing, or traditional VC with ESG clauses.

• ▸Sustainability is not the problem. Dumb money is the problem. The paper does not show that green startups are worse businesses. It shows that they attract a worse class of capital. The solution is not to abandon sustainability. It is to professionalize the funding process for mission driven companies.

• ▸The best sustainable startups might be the ones that do not talk about it. If the market penalizes sustainability signaling, the smartest founders will hide their green credentials until they have proven their business model. This is unfortunate, but it might be rational. The signal has become too noisy.

The Bottom Line

Mansouri and Momtaz have documented a genuine paradox. Investors say they want sustainability. They pay more for it. Then they lose money. This is not because sustainability is bad for business. It is because the current system for funding sustainable startups is bad for investors.

The paper is a warning, not a condemnation. It tells us that good intentions are not enough. They need to be paired with good incentives. And right now, the incentives are pointing in the wrong direction.

The 28 percent premium is a trap. The 16 percent penalty is a tax. And the only way out is to build a funding infrastructure that treats sustainability as a serious business proposition, not a marketing pitch. That means less crowdfunding, more accountability, and a willingness to say no to founders who are better at talking about saving the world than they are at building a company that can actually do it.