Why ESG is core to a venture capital success?

Marta Zadravec

Venture Capital (VC) is having a transformative impact on large sections of the global economy. While ESG issues have never been greater, investors may think the ESG is less relevant for VC. Tech companies do not directly emit many greenhouse gases or pollute many rivers after all. However, ESG integration for investing can be critical to long term success of venture capital firms.

The need for sustainable investments has grown dramatically in recent years and so has the pressure on investors to integrate sustainability factors in their investments. VC mostly targets disruptive business models that often don’t have developed model of ESG issues. As companies grow, individuals within the company will have their own perceptions of appropriate behaviour and activity which will likely be divergently resulting in a loss of ESG rigour in the corporate operation.

Moreover, tech companies are often at the forefront of emerging ESG concerns. For example, the ethical issue of personal data will become major 2020s human right issue.

That said, VC investors will have greater chances to identify ESG risks with systematically integrated ESG into investment decision making. Moreover, systematic approach is particularly valuable for VC investors because they have smaller teams and bigger portfolios than their private equity peers.

The adoption of environmental, social and governance policies can help mitigate risks and provide a healthy framework for inexperienced founders. Moreover, it can be less painful for the company if ESG has been part of its culture in its early stages rather than being ‘retro-fitted’ under the pressure of investor scrutiny.

With this in mind, VC investors can set the foundations for rapid growth if their company incorporates ESG early on. A clear ESG commitment can also attract Millenials, as sustainable consciousness consumers. A 2019 Morgan Stanley Institute for Sustainable Investing survey of high net worth investors found that 95% of millennials were interested in sustainable investing.

According to MSCI, the interest from millennial investors has already helped drive the rapid growth in ESG investment. Nearly USD 4 billion flowed into ESG funds in the first three quarters of 2019. The year-end total in 2018 was USD 5.5 billion, which at the time was a calendar-year record, but sustainable funds were on track to triple that during the waning months of 2019.

The necessity of ESG due diligence is simply relative to the sector, and so different factors will be diligenced depending on the profile of the business. Therefore, due diligence and manager research teams have been leveraging ESG data to better understand the ESG characteristics of managed products and funds. ESG reporting and data may help align what managers say they are doing with ESG outcomes.

For example, where a manager says they are building a portfolio designed to minimize exposure to climate change risk, due diligence and research teams may leverage ESG reporting to measure the carbon footprint and performance on climate change risk management of a portfolio and compare it to a benchmark.

At Venturexchange, our team can advise clients in devising the ESG strategy and communicating it to various stakeholders. ESG strategy is not a stand-alone issue but should be integrated into the overall company’s strategy, operating environment, and business model.

Our article does not provide all the answers that involve ESG issues, but we hope it provides a framework for VC investors to consider and manage their ESG impact.