Keren Bitan is the founding principal at Tandem Impact, a boutique sustainability consulting firm. She specializes in advising VC firms and high-growth companies, including Norwest, on ESG performance management and impact strategies.
Founders and startup teams are hearing more from investors, customers, and employees about Environmental, Social, and Governance (ESG) performance. But what is ESG, and why does it matter—especially now? When you think ‘ESG,’ think about data security and privacy, employee engagement as remote work becomes the new norm, and all of the governance missteps making news headlines (WeWork, FTX, etc.).
During this time of economic uncertainty, industry leaders continue to suggest that in fact due to slowing growth, investors looking to beat the market must consider ESG factors, including topics like carbon footprint and governance structures. However, many founders and teams are grappling with both understanding what ESG performance means, and the increased pressure to demonstrate excellence in performance across environmental, social, and governance areas.
In this piece, we will share both background on ESG as a concept and actionable advice for fast-growing companies.
What is ESG?
‘ESG’ as a term was first coined in a June 2004 report facilitated by the UN Global Compact and published and endorsed by a group of 20 financial institutions, entitled Who Cares Wins: Connecting Financial Markets to a Changing World. The writers of the report shared that investors should consider environmental, social, and governance factors when making investment decisions, in order to build stronger markets, and contribute to sustainable development that works for everyone, over the short and long term.
Investors should consider environmental, social, and governance factors when making investment decisions, in order to build stronger markets, and contribute to sustainable development that works for everyone, over the short and long term.
Let’s break down what we mean by E, S, and G:
- Environmental: Company impacts on the environment, and environmental needs and risks. Example topics include water usage, greenhouse gas emissions and climate-related risks.
- Social: Company impacts on people, including topics such as employee engagement, supply chain resilience, and internal practices related to diversity and inclusion.
- Governance: Company performance related to fair, accountable and transparent corporate practices and actions.
As the ESG field has evolved, standards and frameworks like ISSB, GRI, TCFD, and others have been developed to provide an avenue for companies to share reliable and comparable information so stakeholders can make better decisions about company ESG performance.
What is ESG Performance?
ESG performance refers to how a company is doing in ESG focus areas. The specific ESG areas a company focuses on should be tailored to their business model, and ultimately drive financial performance and contribute to sustainable growth.
ESG topics can include (not exhaustive):
Investors are assessing performance across E, S, and G dimensions as a way to better understand a company’s ability to create and maintain value.
MSCI shares this objective of ESG integration: “Investing with a systematic and explicit inclusion of ESG risks and opportunities with the intention to enhance long-term risk-adjusted returns.” In practice, this might look like an investor including questions related to carbon emissions, diversity of the board and employees, and responsible product design in their due diligence questionnaire.
The objective of ESG integration is to invest with a systematic and explicit inclusion of ESG risks and opportunities with the intention to enhance long-term risk-adjusted returns.
The integration of ESG factors when determining a company’s potential for positive financial performance has continued to grow.
- In 2020, 92 percent of S&P 500 companies published a sustainability report, and investors are increasingly developing formal frameworks for assessing ESG performance.
- A 2021 PwC survey of VC investors with a majority of European respondents revealed 76 percent currently consider ESG in their investment process, and 37 percent have refused an investment because of ESG concerns.
Successful ESG strategies consider relevant environmental, social, and governance risks and opportunities across operations, products, and services.
Consider example outcomes of focusing on relevant ESG focus areas:
|1. Employee Satisfaction|| |
Engaging with employees, understanding feedback and implementing changes.
Better working experience, higher employee retention, less money spent on training short-term employees.
|2. Data Security|| |
Implementing best practices related to data security protocols, providing clarity to customers.
Fewer successful hacking events, more consumer trust, increased usage and revenue.
Consider example outcomes of neglecting relevant ESG focus areas:
|1. Climate Risks|| |
Ignoring potential physical impacts of climate change, when core engineering functions are outsourced in an area with high risks of flooding.
Offices and contractors are impacted, uptime is compromised, customers lose trust, loss of revenue.
|2. Ethical Technology Development|| |
Training an algorithm with a homogenous group of testers or flawed data sampling.
Perpetuate discrimination and human biases through technology and products, less accurate outputs.
Good governance can help drive long-term growth
Take a look at what Norwest’s portfolio founders and CEOs said are top of mind issues for them and learn how specific governance practices support sustainable growth.
ESG vs Impact Investing: What’s the Difference?
An important distinction to understand is the difference between ‘impact investing’ and ESG integration into investment decision-making. Impact investors are focused on investing only in companies with a mission to make a positive difference either in peoples’ lives or for the planet, while all investors can integrate ESG considerations as they evaluate and invest in every type of company.
Impact Investing: ‘Impact investing’ is focused on measuring the positive impacts of products or services alongside financial return. Impact investors seek to invest in companies with a purpose to deliver measurable positive social or environmental outcomes. Impact investors might target companies that focus on reducing poverty, increasing educational opportunities for underserved communities, or climate technologies.
ESG Integration: In contrast with impact investing, all investors can choose to integrate ESG performance into investment evaluations. ESG integration means an investor is including relevant ESG factors in analysis and investment decisions, with the intention to enhance risk-adjusted returns. For example, an investor considering whether to invest in an enterprise SaaS company might evaluate how the company protects against cyber attacks, and how the company ensures employee satisfaction.
What Are the Benefits of Developing ESG Strategies?
1. Attracting capital. Both startups and VCs are recognizing they are more likely to secure funding if they implement intelligent ESG strategies.
2. Financially outperforming your peers. Studies continue to suggest companies that prioritize ESG demonstrate financial success. A recent NYU Stern meta-study found 71 percent of studies show companies with strong ESG performance financially outperform their peers or have a neutral result (58 percent positive results, 13 percent neutral, 21 percent mixed, 8 percent negative results).
3. Attracting and retaining high quality employees. At Fiix Software 78 percent of employees stated the company’s sustainability program influenced their decision to join the company, and almost 90 percent stated the program influenced their decision to stay at the company. A majority of startups in a recent WEF survey shared that employees and customers are the main drivers for implementing ESG strategies.
4. Demonstrating sustainability to both consumers and enterprise customers who care. Both large enterprise customers and consumers alike are seeking to manage their own sustainability through who they choose to buy from. For example, Microsoft requires key suppliers to complete a CDP questionnaire. A 2021 PwC survey revealed, “83 percent of consumers think companies should be actively shaping ESG best practices.”
5. Staying ahead of upcoming regulations. Regulators are starting to propose and implement disclosure frameworks related to ESG topics. Even for startups not seeking to exit anytime soon, proposed disclosures will likely impact both private companies in the supply chains of publicly traded companies, and public LPs of venture capital GPs.
Integrating ESG principles early is more effective than attempting to retool later on. For example, it’s easier to establish a culture of scanning for unintended consequences (e.g. mental health impacts of social media filters) using a tool like doteveryone’s Consequence Scanning when the product design team is 10 people versus 100 people. Or on the organizational side, another example—it works better when founders and teams establish inclusive hiring practices when the organization is 20 people, instead of waiting until the company is 400 people.
Take a look at how Norwest approaches ESG and DEI
What About ESG Critiques?
It’s useful to consider ESG critiques while building your strategy, as those same critiques can be helpful in developing your approach (take a look at some commentary on corporate sustainability here). For example, make sure to avoid greenwashing by focusing on relevant ESG focus areas for your business, and actually develop strategies to address risks and opportunities—don’t just focus on marketing or communications. In a future piece, we’ll dive into common criticisms and how you can avoid those pitfalls.
‘ESG’ as an umbrella term can be useful, but if you stop at generalized concepts you won’t make progress on the real risks and opportunities that will prevent or drive profit and sustainable development.
Some Relevant ESG Practices to Implement If You’re Just Getting Started:
- Define your corporate purpose: what you will do for profit that will benefit a broad group of stakeholders, including people and the planet.
- Develop a diverse board. Ensure independent director(s) are on the board.
- Do a lightweight materiality assessment and make relevant commitments (e.g. Net Zero targets, implementing responsible supply chain policies—who you will or won’t buy from).
- Integrate processes into product design and development and business operations that consider key ESG risks and impacts (e.g. implement responsible product design practices and develop inclusive hiring practices).
- Strengthen governance practices and policies including code of conduct and ethics, anti-harassment, anti-corruption, and whistleblower policies, and board committees.
If You’re Further Along in Your ESG Journey, Consider These Practices:
- Align with global standards and frameworks, start or continue measuring and managing performance in relevant areas (e.g. employee engagement as a percentage).
- Develop a process for continuous engagement with internal and external stakeholders about relevant ESG risks and opportunities.
- Build ESG performance metrics into KPIs for executive team leaders and relevant managers.
- Develop a more robust ESG data management process and controls.
- Disclose ESG-related performance information.
If you are looking to learn more about integrating ESG practices, take a look at the ESG Inquiry Tool, developed by Tandem Impact.
Norwest takes pride in the support, mentorship and guidance we provide to portfolio leaders as they build their companies for enduring success. We’re at the ready with the resources you need to start or continue your ESG journey and invite you to get in touch with Portfolio Services to start a conversation about how we can help.
Photo credit: Nathalia Segato