How VCs Can Help Startups Set (and Meet) ESG Goals – Harvard Business Review

How VCs Can Help Startups Set (and Meet) ESG Goals  Harvard Business Review5 ESG Themes For Next Year  Morningstar.caFive sustainable investment trends for 2022  Fidelity InternationalClimate and pandemic risks among MSCI’s top ESG trends to watch in 2022  Investment WeekESG researchers highlight the hottest trends of 2022  Financial PlanningHow VCs Can Help Startups Set (and Meet) ESG Goals  Harvard Business Review5 ESG Themes For Next Year  Morningstar.caFive sustainable investment trends for 2022  Fidelity InternationalClimate and pandemic risks among MSCI’s top ESG trends to watch in 2022  Investment WeekESG researchers highlight the hottest trends of 2022  Financial PlanningHow VCs Can Help Startups Set (and Meet) ESG Goals  Harvard Business Review5 ESG Themes For Next Year  Morningstar.caFive sustainable investment trends for 2022  Fidelity InternationalClimate and pandemic risks among MSCI’s top ESG trends to watch in 2022  Investment WeekESG researchers highlight the hottest trends of 2022  Financial Planning

A competitive advantage can be gained by being the first to move an ESG-oriented VC funds. It will attract high-quality portfolio companies that are willing to address the most pressing issues of today, such as the climate emergency. VCs must improve their screening and selection capabilities, rethink their valuation models, and redesign term sheets to include ESG issues. Large, established companies have had to take action. They may need to reinvent their business models or radically reengineer their products, services, or operations in other cases. These actions are essential to ensuring a sustainable future. However, large companies cannot do this on their own. They shouldn’t. These solutions should also include young, fledgling ventures. However, VC funding for such startups is critical if we are to address society’s most pressing issues. We conducted 17 interviews with 25 people from 15 different markets, including the European Investment Fund (EIF), FMO Ventures Dutch Development Fund Balderton Beringea and Index Ventures. These participants included LPs, investors and other market participants. While it is becoming more common to incorporate ESG objectives into the VC process, it is still a new practice. It is also difficult: VCs must improve their screening and selection capabilities, rethink valuation models, and redesign term sheets to include ESG issues. Despite these challenges, VCs are more open to incorporating ESG objectives into their portfolio firms. They need to improve their screening and selection capabilities, rethink their valuation models, and redesign term sheets to include ESG issues. Venture capitalists must be able assess, monitor, advise, and recommend ESG performance for their ventures from both the risk mitigation and value creation perspectives. Second, venture capitalists must first strengthen and solidify their claims. This will depend on integrating ESG goals into VCs operating models through incentives, processes, or structures. These changes are essential for VCs to be able to influence startups and to maintain their authenticity in the eyes startup firms. VCs must also find ways to support startups to increase ESG factor incorporation. The processes required to apply ESG elements to startups are different from those used to large public firms. This is because younger ventures have greater constraints in terms of human resources, management capability, and financial resources. These barriers make it more difficult for startups to integrate ESG factors. We believe that VCs should build their own ESG integration capability and ESG based evaluation capabilities within their business model. Based on interviews, we identified three main areas that VCs should prioritize. They must also develop an ESG factor evaluation capability, especially during the due diligence stage. This would allow them to evaluate the extent to which startups have genuinely integrated ESG elements, both in terms risk mitigation and importantly, to capture a growth opportunity. How innovative and unique is the startup’s solution? Can it scale quickly and profitably, while making a positive social impact by addressing the ESG problem? Given current ESG trends, how sustainable is this opportunity? And how easy can others copy the solution? ESG integration not only enhances a VC’s due diligence but also allows the company to make better investment decisions. ESG integration should be considered not only at the due diligence stage, but also as the startup grows. ValuationValuation should accurately reflect the long-term social and environmental impact of startups with strong ESG factors. Investors must develop new tools for measuring investments that have the core objective of generating financial performance and positive social impact in an integrated manner. Benchmarking and comparable multiples will be required. Information sharing about returns on ESG-oriented startups is also essential. There is a rapid buildup of multiple databases and sources for financial information about startup funding and valuation. These tools are rapidly expanding with the goal of increasing investors’ sophistication in making decisions in the ESG space. Term sheet, monitoring and metricsWe discovered that a growing percentage of VCs include diversity metrics in their information requirements for new portfolio companies. There are many other factors that need to be considered. The rules of the game are traditionally set out in the term sheet. Now, the key question is how to incorporate ESG criteria that are effective, b. drive value and c. are not an excessive burden for portfolio firms. As a sign of their commitment to ESG issues, we identified several European VCs who have been pioneering the incorporation ESG factors into their term sheets. To fully integrate ESG into the term sheet, VCs should be unafraid to engage with startups directly on ESG issues (i.e., specifically develop an ESG engagement plan); they should use voluntary materiality frameworks from public markets as a starting point for exploring material ESG issues in the startup’s industry; and they should be willing to experiment and learn through trial and error about the type of ESG rules that can be effective.Identifying priority ESG factors is key. Our interviews show that there is no one-size-fits all approach to ESG. A biotech startup may have different needs than a fintech startup. A company that develops electric cars’ batteries will have different needs than one that works with plant-based alternatives like Oatly or Impossible Foods. Provided that VC is an industry specialized by sectors, VCs from the same sector may be able to work together, in the same way that they syndicate deals, to identify most relevant ESG factors.The Purpose of the VC IndustryInstitutional investors, i.e., the limited partners in VCs, are actively searching for more ESG-oriented investments in the private capital market. A competitive advantage can be gained by being the first to move an ESG-oriented VC funds. It will attract high-quality portfolio companies that are keen to address the most pressing issues of today, such as the climate emergency. The VC model, but also the purpose of the VC industry, may be reimagined to meet a new and ambitious goal: To identify and finance ground-breaking business models that will support our global efforts towards a more sustainable future.

Read MoreHow VCs Can Help Startups Set (and Meet) ESG Goals  Harvard Business Review5 ESG Themes For Next Year  Morningstar.caFive sustainable investment trends for 2022  Fidelity InternationalClimate and pandemic risks among MSCI’s top ESG trends to watch in 2022  Investment WeekESG researchers highlight the hottest trends of 2022  Financial Planning