Malk Partners recently hosted a panel at Private Equity International’s 2022 San Francisco edition of Responsible Investment Forum to discuss different approaches to integrating ESG into the Venture Capital space. We were joined by Mike Hinkley from Insight Partners, Sonia Lagourgue from Georgian, and Ramanan Raghavendran from Amasia to discuss the growth of ESG in Venture Capital and the role it plays in their investment processes.
Drivers of ESG Adoption and Industry Trends
Malk has seen drivers for ESG adoption from every angle, from founders requesting support and guidance on ESG-related topics to LPs setting higher expectations for Venture Capital investees.
While LP requirements have been a driver for both Insight Partners and Georgian, Raghavendran articulated a different journey. As a purpose-driven investor, ESG adoption was prompted by a growing awareness that Amasia needed more certainty its investments were succeeding in doing good. Malk has seen that integrating ESG into the investment process is essential for purpose-driven investors to manage potential risks to impact, making it likely that there will be quick adoption of ESG by thematic and impact investors in the Venture Capital space.
Despite macroeconomic trends, all three panelists reported the adoption of ESG has remained strong, if not accelerated, during the market slowdown as founders are increasingly focused on non-economic performance and finding investors who can provide support in this area. Hinkley added that the slower transaction pace has allowed investors to engage more deeply during the diligence process, which helps lower traditional barriers to integration. With fewer transactions and exit opportunities limited in the current market, Malk has seen a trend of investors focusing on their existing investments, making it a good time to extend integration of ESG into investment management practices.
Lagourgue shared she has seen an uptick in engagement from management teams and their willingness to work with investors, as founders are increasingly looking for investors who can provide resources and guidance on best practices – including on ESG. Georgian has been piloting a strategy for providing these resources at scale by creating collaborative portfolio company peer groups to share challenges and identify solutions for common areas of focus, such as diversity, inclusion, belonging and equity (DIBE). Lagourgue shared that portfolio companies who implemented intentional and consistent DIBE practices and participated in these collaborative groups, out-performed across a variety of talent key performance indicators, demonstrating how actively integrating ESG into ownership practices can deliver long-term value.
Right Sizing ESG for Venture Capital
Many of the existing standards for ESG were built for large public and private companies and have yet to be adapted to fit the needs of Venture Capital, where investors face stiff competition and must make investment decisions quickly, creating hesitance towards adding an additional layer to the diligence process. The panelists described this as a key challenge for successful integration of ESG into Venture investing.
For Insight Partners, which invests at every stage and faces the challenge of right sizing ESG practices, Hinkley shared that the approach has been to build flexible strategies for incorporating ESG at each investment stage with options to scale back diligence based on company size and stage.
Similarly, Lagourgue explained Georgian has right-sized ESG for the needs of their targets by adapting traditional ESG frameworks originally designed with larger companies in mind, like Sustainability Accounting Standards Board (SASB) and Task Force on Climate-Related Financial Disclosures (TCFD), into the pre-investment and diligence process.
However, the real benefit of integrating ESG into the investment process, according to Lagourgue, comes from the value creation stage following investment where Georgian can use ESG to help portfolio companies create a competitive edge, making selecting an investor who has incorporated ESG into their investment and ownership practices a more attractive partner.
Raghavendran doubled down on the importance of integrating ESG from the beginning and the significant influence early-stage investors have on the trajectory of a company’s growth, “By definition, our very small companies very quickly become large companies…and even as minority investors, [at this stage] our influence is significant.”
While every firm will ultimately need to choose an approach to integration that matches their unique needs, Lagourgue believes there is an opportunity for Venture Capital firms to collaborate with LPs and tailor ESG to Venture Capital ownership models where investors often have much less control than later-stage investors but where ESG can create strong value-creation opportunities.
- To successfully integrate ESG in Venture Capital, right-sized strategies should be applied instead of the traditional approaches of later-stage investors, which can be burdensome to early-stage companies and firms
- Venture Capital firms should strive to engage LPs on shaping what industry wide ESG integration expectations look like for the asset class to encourage more widespread adoption
- Adopting ESG as impact or purpose-driven investors can help manage risk to impact and provide further support for thematic investment theses
- Founders are increasingly willing to engage on ESG topics and are often looking for investors who can provide resources and guidance in these areas, making integration of ESG into investment and ownership practices a potentially competitive advantage for investors and their portfolio companies
- Venture Capital investments typically result in limited control, requiring investors to rely on relationship building and influence to encourage founders to adopt ESG best practices
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