Will ESG increase my value?
Remarks by Dr. Jan Dauman, CEO, InterMatrix; co-Founder and Trustee, IBLF Global
Let me start by saying that the question “will ESG increase my value” doesn’t make much sense to me, because the answer is “it depends”. What we actually need to know is how to apply ESG principles to reduce risk, create opportunities, add value and maximize valuation.
So to ESG. It’s really nothing new. Successful corporates and many private companies have applied ESG principles for a long time.
What is new are major changes in the business environment following the 2008 global financial crisis and accelerating in the past 7 years or so. And now, of course, we have the added major challenges of covid, spiraling energy prices and inflation, and the war in Ukraine.
In the business world, large institutional investors have recognized that, as part of their fiduciary duty to their investors, they need to act on long-term societal challenges, starting with climate change but now expanding to a wide range of social and governance issues. So they have added action on these challenges to their criteria for investing in corporates and funds.
Many private equity funds are following the same course, either voluntarily or responding to pressure. And so we see more and more shareholder resolutions to pressure investee companies on ESG issues.
And we see many large corporates measuring and reporting on their ESG performance and also now adding ESG criteria to due diligence and decisions relating to their supply chains and acquisitions.
Most western governments are making legislation on the biggest challenges, including climate, inclusion, human rights, online harm, and so on a priority. There are new laws and regulations almost every week.
Activists, using social media, have become more articulate and effective in piling on the pressure.
In our industry, the recognition that the huge benefits of the disruption caused by tech advances are often accompanied by serious negative consequences, with major associated risks to reputation and more and more legislation.
And, finally, and very importantly, we are seeing a major change in values, especially among younger generations but also among HNWIs and other investors. In London, I belong to the Conduit Club, which has dozens of angel and early-stage investor members committed to only investing in companies that meet ESG criteria.
So, what are the key ESG factors?
E is about protecting and conserving nature. This includes climate change, air and water pollution, biodiversity, circular economy energy efficiency, and waste management.
S is about people and communities, including health & safety, data protection, and privacy, diversity, human rights, and labor standards.
And G is about a company’s governance, values, and standards, including board composition, share structure, bribery and corruption, cyber security, the culture of integrity, transparency, reporting, and sanctions compliance.
And, very important, all these factors apply to your supply chains as well as to yourselves and become more significant as you scale your businesses, possibly including through overseas expansion and acquisitions. Experience shows that most behavior risks occur in supply chains and acquisitions.
When thinking about what applies to your particular community of Saas entrepreneurs and VCs, we need to distinguish the macro from the micro. In the macro, we see large FIs, corporates, and governments attempting to “save the world”. And there is a whole industry of consultants, accountants, lawyers, fund managers, government agencies, and non-profits trying to define priorities and measure impact. In my opinion, although there has been some progress, the current situation is a big mess: confusion on metrics, ambiguity, duplication, contradictions, and lots of “ESG-washing”, but, anyway, it’s not for us.
We’re in the micro-world of software SMEs and need to focus on what is material to valuation over the time frame from now to exit. And you will note that while the list of factors contains some risks, actually there are many more opportunities, some of which you are no doubt taking advantage of already.
Under E there aren’t many risks for this community but we have to watch for new legislation. And there are issues you know about with crypto and blockchain. I don’t know what is happening in your Region but the EU is increasingly active.
Software products and services for energy efficiency, waste management, and the circular economy are all obvious opportunities.
Under S… Clearly one of the main material factors for this community is data protection and privacy, including issues around facial recognition, data collection, social media marketing, online safety, responsible AI, and bias and discrimination in algorithms. We can expect more and more controversy and regulations. Key questions include who is responsible and who is liable when things go wrong.
Under G… Board composition and share structure are especially important. Having an independent director is recommended, if not at the seed stage then to secure Series A funding. Dual-share class structures are frowned upon. And watch out for conflicts of interest.
A key emphasis is on transparency and reporting. As part of their due diligence, investors will want to review policies and actions on the ESG issues they regard as material. My recommendation is to be proactive, find out ahead of time exactly what investors want to see, and include the information in the data room.
Of course, these challenges apply to VC funds as much as to their investee companies. Implementing robust ESG due diligence is fast becoming imperative to create long-term value and create commercial advantage, not least because an increased number of LPs will demand it before they invest. On the other hand, VC funds that ignore ESG or adopt a reactive approach to it, risk being caught out by legislation, damaging their reputation, and being ignored by the best LPs.
VC funds have a unique opportunity to accelerate the growth and valuation of the companies of the future, not only with capital but also with guidance throughout scaling. The earlier they make ESG matter in the VC lifecycle, the better prepared their investee companies will be to minimize risks, capitalize on opportunities and meet challenges as they scale, and to maximize their valuation at each investment stage.
One well know example…… Amidst the controversies surrounding Deliveroo about the misclassification of riders as self-employed, institutional investors, including Aviva, M&G, and Aberdeen Standard publicly declared that they would not invest. This had a major impact on the bottom line of the many VCs and angels who had funded the company to that point.
Most ESG focus to date has been on large FIs and corporates and it’s only recently that attention is being given to VCs…. And now it’s a lot of attention. There is a very interesting report by the United Nations PRI, Principles for Responsible Investment (to which some 4000 FIs have signed up), called “Responsible Investment in Venture Capital” which you may wish to look at.
I leave you with this thought: History shows that companies, large and small, that anticipate changes in the business environment and integrate relevant ESG policies and practices, at the same time also do most other aspects of the business well…such as product development, marketing, and HR……thereby building reputation, creating value and increasing valuation.
It’s just good management!
About Jan Dauman
A few words about my background. As an entrepreneur, I founded an international business development and coffin firm called InterMatrix some 40 years ago and grew it to have subsidiaries and affiliates in 15 countries in Asia, Europe, and the US. After the Berlin Wall came down, in Central and Eastern Europe I partnered with Central Europe Trust, CET, which some of you may know. You’re probably too young to remember but CET co-managed with AIG the $320m New Europe Fund, the first PE fund in the Region.
In parallel, I ran an InterMatrix consulting practice focused on working with large international corporates on integrating responsible business practices, what the world now calls ESG, into core business operations. So I’ve been in the ESG world longer than most people.
I then acted as an independent director on several boards of both listed and unlisted tech companies, including 7 years with Asseco SE Europe, which is listed in Warsaw and which some of you will know. For 8 years, I chaired an events management software company from start-up to exit. Nowadays, I’m an investor in entrepreneurial companies, I mentor entrepreneurs, I’m on the Board of a non-profit that I co-founded called IBLF Global, which is focused on helping SMEs in emerging markets combat corruption, and I’m on the Advisory Board of Ocean14 Capital, an impact fund.