ESG

What do start-ups expect from venture capital funds when it comes to ESG?

Startups should embed ESG principles into corporate strategies.

Start-ups should embed ESG principles into corporate strategies. Image: Pexels.

Shrinal Sheth
Project Lead, Financial Innovation, World Economic Forum
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ESG

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  • Venture capital firms are a critical force in shaping the future of people, planet and society as they invest in leading start-ups.
  • A new study by the World Economic Forum reveals the challenges and opportunities for start-ups wanting to build ESG strategies.
  • Insights from the study reveal what start-ups expect from venture capital funds in relation to ESG.

Venture capital (VC) plays a transformative role in society given the nature of the disruptive business models and companies VC funds invest in. Even though these funds take up minority stakes in companies, that typically gets diluted in subsequent rounds of funding. VC funds through their active-engagement model can set the foundation for long-term and sustainable value creating companies.

In the past 18 months, many VC firms have realized this and are beginning to scrutinize their own Environmental, Social and Governance (ESG) strategies. There are some who are suggesting or even requiring start-ups to embed these considerations into their business activities.

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Therefore, over the past six months, the World Economic Forum conducted a survey and interviewed start-ups from the Forum’s Global Innovators and Technology Pioneers communities. Respondents were asked to share their views about ESG and their expectations of VC funds when it comes to ESG. The findings have been published in the report ESG Pulse Check: Getting the Basics Right for Startups and Venture Capital Firms.

Here are three key insights for VCs:

1. Investors must demonstrate their commitment to ESG through successful case studies

Start-up founders are increasingly looking for ESG-related value proofs from their investors before bringing them onto their cap table. While the funding environment for start-ups is tightening, with a funding drop of 23% in the second quarter of 2022, start-ups are evaluating who they raise funds from in a more nuanced manner, including aspects such as commitment to ESG and how they prioritize various factors within E, S and G separately. In the survey, 64% of start-ups said that the sustainability expertise of investors is a factor when they think about fundraising.

We are looking for investors with deep expertise and a demonstrable track record in investing and prioritizing ESG factors in their portfolio companies.

Charles Bark, Founder and Chief Executive Officer, HiNounou
Start-up founders are increasingly looking for ESG-related value proofs from their investors before bringing them onto their cap table.
Start-up founders are increasingly looking for ESG-related value proofs from their investors before bringing them onto their cap table. Image: World Economic Forum

It is imperative for VCs to show what they are doing while sharing how they are taking their responsibility of action forward. Further, start-ups must complement venture capital efforts by looking at ESG multi-dimensionally, so that it doesn’t just become a marketing issue.

Katrina Donaghy, Co-Founder and Chief Executive Officer, Civic Ledger

2. Investors can provide differentiated value by meeting portfolio companies where they are in their journey and by providing sustainability as a service

VCs can use the power of their networks to identify key insights that can help portfolio companies effectively embed and deploy ESG strategies. The topic of education and capacity building was a recurring theme across the 45 survey responses, workshop and interviews, conducted by the Forum.

Investors should help founders by educating them on ESG topics and bringing their expertise to board meetings, just as they do on the product and financial side.

Maria Carolina Fujihara, Founder and Chief Executive Officer, SINAI Technologies

In addition, it is imperative for VCs to meet start-ups where they are in their journey. Starting small, for instance, by aligning on the one key ESG issue that the start-up has the potential to make a disproportionate impact on and building from there using the services that investors have to offer can add great value to both sides.

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3. Investors should be flexible and focus on tailored metrics for their portfolio companies

While ESG metrics can be a helpful way to gauge and alleviate potential risks for start-ups, investors must recognize that there is a significant gap in the supporting ecosystem of ESG benchmarks, relevant indicators, measurement tools, etc. In this scenario, levying onerous reporting requirements on start-ups can do more harm than good as these companies have limited resources to balance growth and sustainability.

Good news is a powerful thing. Investors can move the needle by sharing case studies that can clearly outline the tangible operational and tactical benefits of integrating ESG into their portfolio companies.

Aba Schubert, Co-Founder and Chief Executive Officer, Dorae

During the Forum’s survey and interviews, start-ups mentioned the need for investors to be flexible and work with the companies to identify a small but material set of ESG metrics that fit with the company’s strategic vision. Further, these metrics must be chosen in a way that enables the next set of investors to also find meaning in ESG reporting. Many respondents also mentioned the benefit of VC firms sharing success stories of their portfolio companies to highlight qualitative insights about the progress of these start-ups.

To find out more about this topic, read the World Economic Forum's insight report ESG Pulse Check: Getting the Basics Right for Startups and Venture Capital Firms.

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The views expressed in this article are those of the author alone and not the World Economic Forum.

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