ESG in venture capital

One of our interns, Tarkh Lingamallu, asked if he could write a post for our blog about an investing topic he cares about. We of course obliged. Below is his post. Nice work Tarkh!

As ESG issues become increasingly important, startups and venture capital firms will need to enhance their ESG skills and understanding. Founders must be prepared to address ESG concerns in their business models and strategies, while investors must ensure that their portfolio companies are adequately equipped to manage ESG risks and opportunities. In fact, EY reports that “26% of investors decided in 2022 not to invest with a manager because of inadequate ESG policies.” This statistic was a staggering 5 points higher than the previous year. It is becoming clearer and clearer that a greater focus must be placed on conducting thorough due diligence on ESG factors during the investment process and engaging with portfolio companies to drive meaningful change.

Investors, regulators, and consumers are demanding more credible corporate disclosures from companies of all sizes. Startups should consider voluntarily disclosing their ESG performance and progress to build trust with stakeholders and demonstrate their commitment to sustainability. Adopting standardized reporting frameworks can help startups communicate their ESG efforts more effectively and combat any potential greenwashing accusations.

Startups seeking venture capital funding will need to demonstrate how they are integrating ESG considerations into their overall business strategy. This includes setting concrete goals and targets related to climate change, diversity and inclusion, and social issues. For venture capital firms, this means evaluating startups not only based on their financial potential but also on their ability to address ESG issues effectively. For hedge funds and private equity firms, 57% of firms have a governance structure and around 53% of firms have incorporated ideologies of ESG into their investment process. It’s time for VCs to join the change.

The rise of ESG-focused venture capital funds highlights the growing interest in sustainable investments. These funds target startups that have a positive impact on the environment or society, in addition to offering strong financial returns. As ESG becomes a more prominent factor in investment decisions, startups that can demonstrate their commitment to sustainability may have a competitive advantage in securing funding. However, ESG focused VC funds aren’t the only ones who are contributing to this change — researchers found that ~20% of VCs currently take ESG into account.

As ESG issues become increasingly significant, both venture capital firms and startups need to adapt and embrace the new challenges and opportunities they present.