Why venture capital investors should direct more funds towards ESG.

With many social and environmental crises looming on the horizon, it has become clear that the world cannot return to ‘business as usual.’ Sustainability has seeped into the public consciousness, with more than 70% of global consumers ready to embrace sustainable living choices1.

The appetite for sustainable investing disciplines – be it ethical investing, ESG, or impact investing – has grown tremendously. Among various approaches, ESG investing – the practice of integrating environmental, social, and governance factors into investment decision-making – has gone mainstream. In 2018, ESG investments amassed more than $11 trillion2.

An increasing number of asset owners now perform ESG due-diligence when selecting Venture Capital (VC) fund managers3. However, VC as an asset class remains underrepresented in the ESG dialogue. ESG-focused venture capital and private equity funds in 2018 amounted to more than $280 billion in assets4, accounting for only 2% of the total ESG assets under management5.

The case for ESG investing is not just about doing good. It’s about ‘doing good and doing well.’ A Deutsche Asset Management meta-study compiling 2000 empirical studies found ESG integration to affect corporate financial performance positively6. In a study conducted by Harvard Business School, ESG leaders outperformed ESG laggards by 4.8%7.

Given the fast-paced startup environment, VC investors are skeptical of helping startups with ESG integration in the early stages. A startup might seem to have a minimal environmental or social impact on the surface compared to a large corporation. However, many material ESG issues that plague startups are on the verge of snowballing.

The tech industry – where most VC funds invest - is mired with data privacy concerns, following reports of social media giant Facebook’s poor data handling8. Poor corporate governance and human resource management led to the downfall of real estate unicorn WeWork9. Ride-hailing company Lyft, which claims to be at the forefront of societal change, is stuck in a legal fight against its Californian gig workers for evading employee protection10. Silicon Valley tech unicorns Twitter and Google drew considerable flak over lack of workplace diversity and inclusion. The workforce at the companies comprised less than 3% black tech workers11.

A sound ESG framework can help startup founders think holistically right from the start. By setting the tone for ESG integration from the top, startup ventures can future-proof the business and further explore ESG opportunities. Data privacy startup OneTrust, for example, capitalized on the mounting data regulations and raised $200 million in its first funding round. The startup helps companies comply with Europe’s GDPR (General Data Protection Regulation) law12. When the COVID-19 pandemic hit, talent network Andela was seamlessly able to go remote owing to its flexible work policies. Andela’s employee engagement process runs for more than 20 months, training more than 200,000 engineers. By emphasizing gender diversity, the company taps into a wider talent pool13.

Unlike public equity investors, VC investors can easily steer businesses toward sustainability. VC funds hold power to drive change from bottom-up, whether by backing minority founders, de-risking impact-focused startups, or scaling ideas that tap into underserved markets. By instilling a sustainable company culture from inception, the VC industry can transform the way businesses run and shape the new normal.