How to get started with ESG in VC
with Sophie Gupta, Principal and Head of Responsible Investment at Yaletown Partners, August 9, 2022
We were excited to follow up our well-attended session on How to get started with ESG for Startups with a VC-focused session. After all, many of the challenges are the same: are venture-backed companies (especially in the early stages) impactful or mature enough for ESG to be relevant? Much attention on ESG in recent years has been focused on publicly traded companies and the funds that invest in them. But there’s a strong case to be made for ESG integration earlier in a company’s lifecycle, and therefore for investors in those stages to pay attention.
We were interested in what adoption of ESG looks like in VC nowadays. Almost 90 people registered for our event on August 9, 2022, and we had lively conversation around whether ESG matters for venture capital and how the market is evolving.
I. ESG creates value
Research across asset classes has shown a positive correlation between company ESG performance and financial returns, so it’s reasonable to think that this relationship holds for VC, as well — though studies on the link between ESG and VC specifically are sparse. The research that has been published, however, shows that ESG-minded VC-backed companies are ~20% more likely to secure follow-on investment.
Additionally, new investor disclosure-focused regulations — namely, the wide-ranging EU SFDR, and the potential rules that may result from the SEC climate risk disclosure proposal earlier this year– will dramatically raise the bar on ESG reporting. We expect significant waterfall effects even for funds who are not directly affected. For example, venture funds that may not be based in the EU but receive investment from an EU-based LP are likely to receive ESG data requests from this LP, who will need to comply with the regulation. Finally, VC plays a crucial role as the first institutional investor in future business leaders, a crucial position in which to influence not only which companies are built but also how.
II. Key partners care about ESG
LP interest and commitment to ESG continue to grow. As shown by a recent ILPA-Bain study, LPs around the world expect their allocations to ESG, ESG reporting requests, and in-house ESG capacity to grow over the next 3 years. If LPs continue to ask for ESG data, we expect it to increasingly become table stakes for GPs to report on ESG, and therefore to collect, analyze, and use ESG information in portfolio management and company support.
ESG topics are also increasingly important to VC’s other key stakeholders: startup founders and operators. Reams of data show that talent is more and more interested in a bigger purpose, and that DEI is key to building innovative teams and to attracting and retaining talent. Customers are also increasingly aware of how they spend their procurement dollars, and are looking to their vendors and business partners to help them reach their own ESG objectives.
III. Market landscape: who’s taking action?
ESG in VC is still really on two tracks: climate tech, which saw a banner fundraising and dealmaking year in 2021, and well, everyone else. From our vantage point, ESG is just starting to permeate generalist VC, and unsurprisingly, the practice is much more advanced in Europe. A 2021 study indicated that only 10% of VC firms have an ESG policy, ESG DD, in-house ESG capacity, and benchmarks, and 72% do not disclose any ESG consideration publicly.
Nonetheless, we see clear signs of change, namely, the creation of several industry initiatives to tackle ESG as pertinent to VC specifically, e.g. ESG_VC and the UNPRI’s VC working group. More anecdotally, Eliza and I have both been in touch with a number of startups building ESG data collection, analysis and benchmarking tools for startups and for their VC investors, rushing to fill a clear gap in the market.
IV. Case study: Yaletown Partners
To shed light on what it looks like to consider ESG at a venture capital firm, Eliza and Claire hosted Sophie Gupta, a Principal on the investing team at Yaletown Partners as well as the firm’s Head of Responsible Investing. Sophie brings 10 years of experience as a corporate and technology lawyer and trusted advisor to tech companies. A passionate advocate for women’s rights, Sophie co-founded the Equality Fund, which combines international grantmaking with an innovative approach to impact investing through a gender lens to support the advancement of gender equity globally. Sophie also co-chairs the Diversity & Inclusion Committee of the Canadian Venture Capital and Private Equity Association.
In her remarks, Sophie shared Yaletown’s journey taking on ESG in a way that is true and useful to her firm. A few elements stuck with us:
- Start where you are in the investment lifecycle. Most VC firms are small organizations where most employees wear several hats. A VC’s focus will shift when raising a fund, deploying capital, and harvesting gains. Yaletown took steps to evolve its approach to ESG journey in 2019, when it had already invested most of its second fund. It was natural to bring ESG considerations into its portfolio management work rather than into due diligence, for example, and Sophie decided to formalize Yaletown’s ESG work by developing tools and processes.
- Go in with an open mind, and meet your partners where they are. One of Yaletown’s first efforts was to establish an ESG baseline of its portfolio: were executives interested in ESG? Did they have initiatives already underway? Did they want targeted support or high-level guidance, or could they share lessons and success stories for other portfolio companies? Yaletown designed an onboarding questionnaire and followed up with conversations to complete the picture and receive feedback from investee companies’ leaders. Sophie learned a lot about Yaletown portcos’ interest, competency, capacity, and confidence in ESG, clarifying portfolio’s strengths and opportunities for Yaletown to step in with support.
- Similarly, Yaletown was open with its LPs about its process and aims: namely, to learn. It shared its approach and lessons along the way, candidly pointing to lessons learned and soliciting feedback. The firm has quickly evolved its approach to best fit its portfolio and LP’s needs, in large part because it’s been so transparent and open to feedback.
- Don’t be afraid to make changes. Sometimes what sounds like a good idea doesn’t quite pan out when confronted with reality. What started out as a quarterly ESG data collection questionnaire has turned into a biannual exercise once Yaletown heard from its portfolio companies that the data it was looking to collect wouldn’t change much from quarter to quarter. Yaletown is also reviewing its ESG due diligence tool to make it more streamlined and impactful.
V. Takeaways: ESG can deepen crucial business relationships
Yaletown has sought to understand and support both its portfolio companies and LPs on their respective ESG journeys. This conversation and collaboration across the value chain has allowed the VC to deepen relationships that are core to its business, connecting with partners in new ways. It’s also led the firm to be more intentional about its internal processes, from its due diligence and investment work but also in its hiring and recruiting.
More generally, the CDP’s 2020 financial services disclosure report estimates that financed emissions can be 700 times a financial firm’s direct operational greenhouse gas footprint. Working to integrate ESG in a way that is additive can help venture capital step up to its role as first institutional investors in future business leaders.
We’re hosting a discussion about how to get started with ESG at a newly public company (August 31) in a few weeks. Sign up here!
If your organization is looking for help developing or implementing your ESG strategy, get in touch! We’d love to continue the conversation.
Claire Veuthey, Rizoma Ventures & Eliza Erskine, Green Buoy Consulting