Due to the growing interest in responsible investment and therefore from VCs, the industry will need to become familiar with the concept of ESG.
ESG stands for environmental, social, and governance which are a set of criteria used to measure an investment’s sustainability and societal impact.
Here at Antler, we are on a mission to fundamentally improve the world by enabling the world's most exceptional people to build the sector-defining companies of tomorrow. Here is our take on ESG from the VC perspective.
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As ESG is a relatively new concept, and as we recently discussed on FT’s Sifted, there is no universally accepted way to measure ESG implementation for a VC.
Even though there are internationally recognized ESG frameworks that are used in multinational businesses, which are used to measure the deployment and impact of ESG policies, these have yet to find a universal way to measure ESG implementation in VC.
At Antler, we want to change that. It is important to us that both Antler and our portfolio companies create sustainable value, make a positive contribution to the world, and lead the way in terms of diversity.
From our experience, the vast majority of the founders we work with have high standards for ESG; and more LPs, especially the larger institutions, are now pushing funds for more clarity on their implementation of ESG.
The implementation of ESG at the early stages can vastly improve portfolio performance. Companies that implement ESG typically perform 4.8% better than those who do not, according to HBS. These companies performed better when considering accounting rates or return, ROE, and ROA.
According to research conducted by Deutsche Bank which evaluated 56 academic studies, 89% of these studies showed that companies with high ESG factors outperformed the market in the medium (3-5 years) and long (5-10 years) term.
Furthermore, Limited Partners increasingly expect VC funds to demonstrate a meaningful approach to responsible investment. According to a survey conducted on 22 000 investors by Schroders Global Investor Study, 78% of investors felt that sustainable investing is more important now (in 2017) compared to 5 years ago, and 64% had increased their sustainable investments over the past 5 years.
It is worth considering the end-users of portfolio companies’ products and services, too. Nowadays, the purchasing decisions of customers, especially millennials, are increasingly values-driven. In light of climate change and gender inequality, consumers demand solutions that not only mitigate any negative impact on the environment and society, but also contribute to improving the global state of affairs.
VC’s will probably want to monitor the ESG impact of their fund, and that of their portfolio companies.
Using the guidelines you have chosen and formalised for your fund (such as the UN PRI, which we talk about below), VCs should create measurable goals. Without goals, you do not have an effective ESG policy. But having clear objectives will confirm when ESG accomplishments have been hit (or missed).
Quantitative goals include tracking the number of jobs created, number of women employed in white-collar roles, estimation of potential contribution to GDP, affect on climate change, emissions etc.; and qualitative targets can include CSR strategy, directional statements, and formalized guidelines.
Once a VC decides what they want to measure, they need to ensure that ESG implementation and monitoring is incorporated into both the investment decision-making and portfolio tracking processes.
Going further, some LPs may require you to provide an annual ESG summary, so it is useful to develop best practices.
We are working on implementing ESG considerations in three stages over the coming months:
a) Pre-investment DD (due diligence): Our investment team assesses each investment opportunity, fills out an ESG DD survey, explains any considerations, and tags the UN SDG goals fulfilled through each opportunity, which are all considered as input for investment decisions and shared with the Investment Committee (IC) members ahead of the committee date.
b) Once we make investments: We encourage all our portfolio companies to agree to our ESG Principles which outline first level principles and good practices, and help us increase our portfolio companies’ awareness and get their commitment. We are currently in progress of incorporating these into our legal investment documentation to ask for even firmer commitment from each of our portfolio companies.
c) Post investment: Once a year we will ask our portfolio companies a number of questions regarding their work and impact on the environment and society around them, their policies, and we conduct an ESG focused training for them.
It is almost impossible to draw up ESG guidelines from scratch, so it is best to follow the best practices of others. We have used the UN PRI’s ESG guidelines as the basis of our own ESG practices.
As such, Antler has chosen to become a signatory of the United Nations’ Principles for Responsible Investment (UN PRI) and has chosen to be guided by the United Nations Sustainable Development Goals (“UN SDG”). The UN PRI is the world’s leading proponent of responsible investing, and as a signatory, Antler follows ESG principles as guidelines for its investment decision-making process.
Under the guidance of these goals, we are committed to improving the ESG impact of our own investing, and to helping our portfolio companies incorporate ESG considerations into their operational decisions.
This will better enable both Antler, and our portfolio companies, to improve health and education, reduce inequality, and spur economic growth in the locations in which we are present, and through the companies we build. We are also committed to ensuring that our portfolio companies make meaningful contributions to GDP, and job growth in the regions in which they are based.
Regardless of many opportunities, embracing ESG in VCs operations carries some challenges.
Firstly, monitoring the ESG impact of a certain startup can be arduous given the early-stage phase of business which is most often nascent; startups seeking funding at VCs usually have little to no operations and therefore have no business processes that would pose ESG risks.
Secondly, investee companies usually have limited to no ESG know-how, so for this reason they may be hesitant to take VCs’ advice to adopt ESG practices. As a minority stakeholder in startups, VCs typically have little influence over the startups’ course of action. Moreover, they may be hesitant to adopt ESG practices as they may see it as something that would cost more resources than traditional methods. From the startups’ perspective, sourcing materials from an environmentally friendly supplier could be more costly, and putting in place all ESG measures could be time-consuming.
Thirdly, oftentimes VCs report their ESG efforts the same way PEs do. However, the means used to measure PEs’ performance would vary from VCs’ due to their typical portfolio and stage at which it invests.
We believe ESG will become commonplace, even though it’s not broadly adopted as yet. Not only does responsible investing help both investors and their portfolio companies drive better performance, but it also will work towards creating a better world. For us, it’s a no brainer.
Here at Antler, we are still in the learning process, trying to figure out the best ESG practices for a VC ourselves. In order to achieve the best results, we are open to hearing from other VCs and engaging in a discussion related to ESG in the VC’s world.