The year 2020 has served up many reminders of the pressing issues facing society, from failures to address systemic discrimination to the impending climate crisis. Moving forward, realizing a more inclusive and sustainable future requires progress on many fronts.
Venture capitalists have an opportunity to embrace ESG, by reframing how they nurture and help build companies from the ground up. Admittedly, it may be difficult for VCs to help early stage companies implement ESG measures when founders are still fine-tuning business models—but the long-term benefits should be worth it and potentially help future industry giants avoid thorny issues (see Uber’s gig worker problem).
Adopting ESG measures at an early stage can take many forms, from data privacy compliance to establishing policies around non-discrimination and gender equity. It’s never too early to start thinking about these important issues.
I recently invited a panel of experts to discuss responsible investing for early stage venture capital in a webinar entitled Too Early for ESG? Accelerating Responsible Venture Capital.
Speakers included Susan Winterberg, a former fellow at Harvard Kennedy School and co-author of the university’s report Responsible Investing in Tech and Venture Capital; Jasper Veel, corporate governance officer at Dutch development bank FMO, which recently commissioned a report providing a framework for VC investors to consider and manage ESG risks and opportunities; and Hilary Wiek, a senior analyst at PitchBook and author of its Sustainable Investment Survey, which includes survey responses from over 650 GPs, LPs and other investors.
Here are some key takeaways from the event:
People often use terms related to ESG interchangeably. The umbrella of sustainable and responsible investing includes both ESG approaches and impact investing, which differ from traditional investing, where decisions are made based on return and risk objectives. ESG investments are screened for ESG risks and valuation creation opportunities, while impact investments are based on a specific impact objective.
There are different ways to approach ESG, according to Winterberg. That includes exclusion, such as choosing not to invest in areas like fossil fuels or weapons manufacturing—or there’s active management, like screening in companies based on a certain profile or looking at ESG in the process of factoring valuations.
Ultimately, ESG can be something that every company considers, says PitchBook’s Wiek. “Any company that’s got property on the coast needs to think about what’s going to happen when oceans rise.” Companies focused on managing these risks are more likely to be sustainable and make it through challenging times.
Tackling ESG isn’t always a top priority for early stage companies, according to FMO’s Veel. For startups with small teams, issues such as governance can seem like a burden rather than a necessity. “Something I think is very prominent in early stage companies is that it’s a constant fight for priorities,” he says.
Among investors, ESG awareness is a key issue Winterberg encountered during her research. “One of the things we learned that was kind of surprising was how many general partners at large venture capital funds had never heard the term ESG before,” she says. She found some investors even resisted discussing the topic of responsible investing, feeling it implied they were being accused of being irresponsible investors.
According to Wiek, a key challenge is measuring and defining impact, because there are different ways to look at ESG. Some asset managers she’s spoken with reported actively pursuing positive impacts and measuring those results, but avoided using those terms because they thought LPs would assume that returns would be lower. “Terminology and measurement are still absolutely a problem,” says Wiek.
And rather than use standardized frameworks to measure impact, most investors PitchBook surveyed use customized approaches. That creates headaches for investors working with a variety of asset managers, as they’re potentially getting a mixture of customized ESG reports.
Ultimately, one of the biggest forces driving both asset managers and asset owners towards sustainable investing is the prospect of improved investment returns, says Wiek–although simultaneously PitchBook’s survey respondents still reported battling the perception that investment returns would be lower. “Convincing other people of that is still a pretty big challenge,” she says.
As an impact investor in emerging markets, FMO has begun seeing VCs and early stage companies as a good entry point to this space, says Veel. The development bank embraced that philosophy after seeing the rise of innovation in fintech and other areas, leading it to amend its ESG approach to fit the space. “Basically for us it was a new asset class,” he says.
The ESG opportunity is clearly on the minds of many investors, with PitchBook’s recent Sustainable Investment Survey garnering three times more respondents than normal, notes Wiek. As further evidence, she points to the 2008 financial crisis for comparison: back then, ESG was a nice thing to have, but institutional investors didn’t prioritize it during the crisis. That has changed in 2020. “We’re seeing people that are doubling-down in this area, instead of backing off like they did in the last crisis,” she says.
Meanwhile Winterberg sees LPs utilizing ESG for risk mitigation or managing reputation risks, while looking for ways to monitor and communicate impacts by accessing data. Simultaneously, she sees GPs approaching ESG as another layer of risk analysis alongside evaluating product-market fit and team.
Getting started with ESG
Even when ESG doesn’t rank highly on an entrepreneur’s agenda, companies should start early, says Veel. That can mean simply identifying ESG risks associated with a specific business. This lays the foundation for robust ESG processes to develop as a startup matures, while potentially opening companies up to other pools of capital over time. “I’ve seen over and over again that it really benefits the company if they start considering it early in their development,” says Veel.
Winterberg highlights a couple areas to explore when getting started with ESG. One is diversity and inclusion, where there’s already momentum in the VC and startup world. Then there’s technology and risk assessment, including building tools startups can use to evaluate likely issues and develop action plans. Finally, there’s a need for data and transparency around early to growth stage companies, meaning collecting and building datasets applicable to ESG.
Overall, sustainable investing appears to be on the rise now more than ever. “Everything I’m seeing is showing that we’ve moved past the ‘what is this ESG thing?’ towards ‘how do we implement it?’” says Wiek. “If they’re already working on implementing it I don’t see them backing off.”
Now it’s time to solidify that progress and accelerate responsible venture capital.
For more on 500 Startups’ ESG initiative, please visit this page.
To learn about PitchBook’s Sustainable Investment Survey, here’s the link.
This post is intended solely for general informational or educational purposes only. 500 Startups Management Company, L.L.C. and its affiliates (collectively “500 Startups”) makes no representation as to the accuracy or information in this post and while reasonable steps have been taken to ensure that the information herein is accurate and up-to-date, no liability can be accepted for any error or omissions. All third party links in this post have not been independently verified by 500 Startups and the inclusion of such links should not be interpreted as an endorsement or confirmation of the content within. Under no circumstances should any content in this post be construed as investment, legal, tax or accounting advice by 500 Startups, or an offer to sell or solicitation of interest to purchase any securities advised by 500 Startups. Prospective investors considering an investment into any 500 Startups fund should not consider or construe this content as fund marketing material. The views expressed herein are as at the date of this summary and are subject to change without notice. The Too Early for ESG webinar included content delivered by independent third parties that are not related to or controlled by 500 Startups. All views and opinions presented in the webinar or herein by third party participants do not represent those of 500 Startups or any of its affiliates or representatives. 500 Startups makes no representations as to or guarantees of specific outcomes from attending or relying on the contents of the webinar or this post.