The private capital industry, consisting mainly of private equity and venture capital, has over $5 trillion in assets under management and invests in hundreds of thousands of businesses worldwide.
Unlike public equities, which trade in publicly listed companies on stock exchanges all over the world, private capital investors engage in mergers, acquisitions and buyouts of private companies.
The main difference between private equity and venture capital is that private equity focuses on later (growth) stage companies across a variety of sectors like real estate, transport, consumer goods, software, food and beverage, financial services, etc while venture firms are focused on earlier-stage companies in the technology and digital sector.
Private capital investors are in a unique position to drive environmental, social and governance (ESG) impact due to both financial and non-financial influence over underlying portfolio companies.
There are other benefits as well. In 2020, KPMG did a research study which found well over 50% of PE firms were using ESG scores and due diligence for price negotiations during the buyout process. This percentage has likely grown leaps and bounds over the last two years.
A few months ago, someone asked us: what about venture and angel funds? The companies they invest in are earlier stage, so is ESG performance applicable to venture capital as well?
The simple answer to this is yes. If we all agree that strong ESG management is good for business, especially in the long run, wouldn’t it make sense to ingrain ESG into the DNA of a company at an early stage rather than at the growth stage?
The latter can also be interpreted by stakeholders (investors, customers, employees, government, the public and media) as employing cosmetic public relation tactics and green washing.
A new white paper published by the World Economic Forum has outlined five ways for the private equity industry in order to play a catalysing role in combating climate change.
By their nature, private equity firms are more directly involved in their portfolio companies than their public asset management peers, and thus able to influence the ESG strategy.
The white paper, “Creating Value through Sustainability in Private Markets,” suggests five steps private equity firms can take to drive sustainability:
1) Invest in capabilities and culture: Those in leadership roles should also possess a “sustainability mindset.”
2) Focus on a long-term plan: Developing the capabilities and culture mentioned above may see hiccups along the way. Stay the course!
3) Communicate the plan along with measurable milestones: This is important to maintain stakeholder buy-in over the long term.
4) Don’t just divest, also transform: Divestment may remove assets lagging behind in sustainability from a particular portfolio, but it does not remove these assets from the global mix. Turn grey assets into green ones.
5) Collaborate to address key barriers: This endeavour cannot be transformative in isolation. Limited partners and general partners across the industry should work together to set ESG standards and policies.
Last month, the United States’ Securities and Exchange Commission (SEC) proposed rules requiring publicly traded companies to disclose climate-related financial information, including their greenhouse gas emissions.
The aim is to bring some much-needed clarity to climate disclosures as well as help investors make informed decisions.
Following this, the question people are asking is: Will private companies one day also be required to disclose ESG and carbon performance?
If this happens, investors financing these companies will become directly accountable for ensuring compliance and there will be a major push in the private capital markets to streamline ESG reporting alongside financial and performance reporting.
For those running private capital firms are wondering how can a private equity or venture fund move towards regularising and mandating ESG disclosures? Forbes lists five ways for a company to begin its ESG journey:
1) Choose a framework/ regulating body: There are a few leading sustainability frameworks, such as the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB).
2) Get support from leadership: Given how central ESG performance is becoming, company leadership should participate in and oversee its strategy.
3) Create an ESG committee: A dedicated ESG committee will keep ESG strategy and progress on track.
4) Develop measurable criteria and goals: Begin by finding the main areas of risk in the company.
5) Document and communicate: Once you have identified your main areas of risk, decide how, and by which metrics, to track their progress.
The writers are among the founding team of ESGTree.com, a technology platform focused around ESG management for private equity and venture capital firms
Published in The Express Tribune, May 9th, 2022.