From compliance to value creation Environmental, Social, and Governance (ESG) will you be ready?

By: Robert Dormanesh and Andrew Kelley

ESG stands for Environmental, Social, and Governance. Private equity and venture capital investors are increasingly applying these non-financial factors as part of their analysis process. Why, to identify material risks and growth opportunities. We see three key areas of influence.

Investors –

Investors are increasingly evaluating the impact that their investments will have based on ESG. They are breaking away from the traditional focus of solely considering returns, and adding a layer associated with ESG opportunities and the associated value creation. The shift is exemplified by the growing number of investors who are using ESG performance indicators when determining where to place their commitments. The resulting sustainable investment strategy has deviated from exclusionary (i.e. avoiding investments not prioritizing ESG) to inclusionary (i.e. seeking investments that do).

Other stakeholders –

Investors are persuading the industry to look beyond their shareholders and analyze other stakeholders. This has resulted in investors and their portfolio companies examining their relationships with employees, suppliers, and communities that they operate in. An uptick in ESG questionnaires from investors has led to developing in-house ESG reporting methods. Portfolio companies are being impacted from a human capital perspective by current and future employees who are looking to align themselves with companies that incorporate ESG. Lastly, suppliers are being examined to ensure enhanced ESG efforts, creating a cascading effect across the supply chain.

Regulators –

Regulators across the globe are increasingly considering sustainability disclosure standards. A potential precursor to what the global economy may experience, the European Union has codified and mandated that its financial advisers and managers publicly disclose the impact that their investment may have on ESG factors.

This is impacting investors from multiple angels. Sources of capital, workforce talent, and regulators, and portfolio companies, are seeking to continue to add value through traditional means while incorporating a new element of sustainability. By focusing on the major issues in each industry and fostering a unified approach among portfolio companies, investors can demonstrate good citizenship and create value.