ESG integration in PE / VC / Family Office Investment processes

The New Investment Process

Of course, private-equity firms aren’t likely to integrate ESG into their management unless they feel it’s in the interest of long-term profitability. While Most private equity funds are not primarily ESG focussed (Impact Funds) the inculcation of ESG in investment processes is imperative forcing them to relook at ESG and work on the impending obstacle of integrating ESG within their investment processes.

While the process mentioned below is a simplified version of the actual process, it throws a glimpse on the change from the existing process of ‘Evaluation- Initial Negotiation – Final Negotiation’ to now the new process of ‘ESG Evaluation - Evaluation- Initial Negotiation – Final Negotiation’

Screening investment options as defined by Fund Managers, credit committees or as mentioned in the original PPM now includes ESG Evaluation . This change is not only a result of the impending climate change but increasing recognition of the importance of ESG issues.

The reasons are unsurprising: changing times reflected in the preferences of employees and customers; growing awareness of the significance of climate change; social expectations regarding diversity, equity, and inclusion; pressure from large public companies to which the portfolio companies are suppliers; awareness of the sustainability focus in publicly listed companies; opportunities to boost their own value through sustainability; and increasing regulation.

Why ESG Integration?

? Besides Regulatory and Operational risks; the other side to implementing ESG is Value creation and a few other factors. The regulations are self-explanatory and the regulations cover the entire spectrum of business so none of the investee companies are spared. More so its like buying insurance for our portfolio companies where we have invested. However the Value creation through possibly higher valuation and business stability is something which every investor seeks for a portfolio company. Most of the large bulge bracket investors are long term and they naturally encourage a lower risk investment scenario, Your commitment to ESG would automatically make your investee companies a preferred choice.

? Further research suggests that most leading corporates have leveraged on ESG to commit to innovation. Research also suggests that such innovation and innovative practices have led to additional revenues as such Intellectual properties / processes have a demand amongst vendors / suppliers / smaller competition and customers.

? “It’s time to shift the ESG paradigm from compliance to impact and value. Investors need to embrace a holistic approach that spans the entire investing value chain, so you achieve superior returns and help create a more sustainable world.”

? Value at Exit: an important factor whilst investing. The ESG regulations will only get stringer and tighter. For an Investor to make a profitable exit 5 to 10 years from now it is imperative that they get their ESG act in place else it will be too late.

? Last but not the least there is a wave of demand from customers and employees alike to prefer ESG focused companies. This gives your investee companies an EDGE not only in operations but also sales.

?Its time to shift the ESG paradigm from compliance to Impact and Value. Investors need to embrace a holistic approach that sans the entire investing value chain, so you achieve superior returns and help create a sustainable world.

Steps for GPs/ LPs / Family Offices / Investors

1.???? Commitment to ESG

a.???? At an organizational level a serious commitment towards integrating ESG is mandatory for the line and staff to own the idea. A charter of belief is ideal where the ESG importance is inculcated at a Vision level. It may not necessarily be a breakdown of activities the fund will incorporate but a high level statement will do; to enable the management and fund managers to enact on ESG across the board.

b.???? Seek formal commitment and a plan of action from investee companies incorporating ESG agenda.

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2.???? Dedicated Generalist Resource

a.???? A dedicated resource like an operating partner will be a much welcome addition to most teams since the entire focus of the team if valuation and deal making. Such a resource acts like a controller within the system where the heads are responsible to file reports on activities but do not report to the ESG specialist. The position calls for a watch dog type of a profile where the person responsible also guides boards and management of various investee companies on ESG. This is possible the single most important step towards ESG.

b.???? The cost of this resource is more than offset by risks avoided and compliance measures at Investee companies.

3.???? Educate

a.???? BRSR reporting principles specifically ask for percentage of people trained in ESG. There is a reason for this. More so in a PE / VC firm since the management at PE forms are a part of multiple boards and their perspective on esg will further strengthen the same at investee companies.

b.???? Educating line and staff at PE /VC firms will help percolate the ESG focus down the line across all investee companies and their vendors, suppliers and customers.

c.????? Educate management at Investee companies on ESG specially Scope 1/2/3 so that they can take informed decisions on their supply chain.

4.???? Integrating ESG in the Investment Process

a.???? This has been covered separately as a topic.

b.???? ESG from Risk and Rewards perspective should be a part of the initial evaluation process.

5.???? Reporting

a.???? Reporting at a PE / VC should cover preliminary activities undertaken at not only the firm but should showcase activities and goals at Investee companies. This is to frame best practices. Its only a matter of time when the PE / VC following this will become a preferred partner to investee companies since this practices enables & encourages other funding agencies and investors to invest in your investee companies.

b.???? Investee companies should be encouraged to formulate a road map on ESG for the next 3 to 5 years.

c.????? Formulate a S (Social) & G (Governance) part of ESG as a reporting measure to the Head of HR at the PE firm

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“Bain & Company Research suggests that over 90 percent of Investors (LP’s) would walk away if the investment opportunity poses an ESG threat.”

A Questionnaire

Please use this as a framework, this should help LP’s / GP’s / Investors design their own

Section 1: Policy and Strategy

1. What is the scope of your ESG integration policy?

2. How do you ensure compliance to your policies among the management teams of your portfolio companies?

3. What processes exists for evaluating or reviewing your policy's effectiveness?

4. Have you committed to any international standards, industry (association) guidelines, reporting frameworks, or initiatives that promote ESG practices?

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Section 2: Materiality ?

1. Process to determine what ESG factors present material risks or value-add opportunities during pre-investment due diligence?

2. Process of Including materiality conclusions into your investment decisions

Scenario Analysis with respect to Materiality fir Investee companies

3. Processes suggested for Investee companies

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Section 3: Leadership & Ownership

1. Building ESG competence at investee companies

2.? Reporting process at Investee companies

3. Human capital resources dedicated to ESG

4. Who is responsible for ESG due diligence and standards compliance and what are his/her responsibilities?

5. Training programs for team and Investee companies

6. Capacity building for board and top management

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Section 4: ?Social and Governance

1. ESG Communication Procedures

2. Diversity, Inclusion for employees

3. Diversity and Inclusion for suppliers

4. ESG considerations for board members

5. Separate capacity development programs focused on Social & Governance

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About CASI

Originated from New York and now present across over 50 countries, CASI is a think tank dedicated to ESG and Sustainability. They also offer workshops and certification programs on ESG, Governance and Sustainability.

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About the Author

Paresh Sheth is the member of the board of directors at CASI Global, New York.? He is also an advisor to a private equity firm based in Germany focused on ESG Investments in Europe.

Prof. Sheth conducts workshops for senior management professionals on ESG, Supply chain sustainability, Strategy and Governance and is a professional board advisor for strategy, finance, M&A and ESG.

His previous experience includes CEO & Full Time Director at Swiss Bank Indian Sub, Director, Business Head and Country Head for Leading Retail bank and Brokerage, Investment Bank and Wealth Management company. He is an alumni of IIM Calcutta.

Prof. Sheth is an author of the #bestseller book on #Financial Literacy

www.casiglobal.us | www.casi-india.com | https://www.esg-portfolio-management.com/en/advisory-board

[email protected] | https://www.dhirubhai.net/in/pareshsheth

?#ESG, #Sustainability, #Sustainabledevelopment, #Privateequity, #VentureCapital, #FamilyOffice # Investors #UNSDG Sustainability @venturecapital Private Equity Venture Capital Leadership Investment Banking INVESTING IN INDIA #impact, #Impactinvestment

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