- Venture capital is crucial in shaping the future of our people, planet and society.
- However, venture capital has been a laggard in considering environmental, social and governance aspects when making investments.
- The tide is now turning as venture capital firms begin to push for adoption of ESG. Here’s how to stay ahead as a startup founder.
If you’re a startup founder who has raised venture capital (VC) funding or is looking to do so, you know that global VC funding hit record highs in 2021 – here are the top five trends to watch out for this year.
What’s interesting is that early-stage funding grew at 104% year-over-year in 2021 to peak at USD 49 billion. VC firms are therefore a critical force in shaping the future of people, planet, and society as they continue to invest in the leading companies and disruptive technologies of the future.
Despite this influence, Deliveroo’s disastrous IPO last year and a report by Amnesty International highlighting the failure of VC firms over human rights due diligence demonstrate that venture capital has been a laggard when it comes to incorporating Environmental, Social and Governance (ESG) considerations in investment processes.
An incessant pursuit of generating outsized returns by focusing on investing, building and, scaling startups that generate rapid growth at all costs, the lack of pressure on VC firms to focus on ESG, and a lack of diversity are likely reasons for the slow ESG uptake.
Venture capital can play a key role in shaping the future
However, several developments over the past 18 months show that the tide is turning:
- The launch of VentureESG, an initiative to push the VC industry on ESG supported by 250+ VC funds and Limited Partners (LPs),
- PRI’s launch of a VC collaboration to improve industry wide practices,
Increasing expectations on ESG integration are now extending to startups and SME businesses. However, there is a gap in the supporting ecosystem of ESG benchmarks relevant to the size of these companies. At Prosus, we set sustainability performance standards at the group level and then work with the companies to identify areas relevant to their business model and operating context.
How venture capital can embrace ESG
So, what can you do as an early-stage startup founder to stay ahead of the curve?
The short answer is – start small and build your company’s ESG capacity as it grows. Setting the foundations of your future is vital, so I’d it now – I can help you with this by guiding you through the 39 ESG policies I offer in the tool kit section of this website.
1. Analyse: In the early-stage, as you focus on getting the product-market fit right, you will likely go through multiple iterations both for your product as well as the business model. While speed is key during this process, take product-market fit a step forward— analyse the second and third order impacts of your product and any changes in your strategy that may open a whole new world of ESG risks and opportunities.
At this stage, it is also important to analyse if the product or service your startup is providing will have a net positive impact on the world. For instance, the value that many tech startups add comes at a great cost to workers’ rights.
2. Identify: While at the outset your company may not seem very risky from an ESG perspective, any unidentified ESG issue will likely scale as quickly as your startup. Therefore, it is imperative to identify material ESG issues that can affect your business not only today but also during the scale up phase.
Studying the ESG risks impacting the sector your startup falls in is a good first step. When raising funds, identifying VC firms that can help grow your business while building your ESG capacity is another important step that can have a great payoff in the long term.
3. Prioritise: As the founder, your goal must be to lay a strong foundation for building robust ESG processes. Just as you ruthlessly prioritise all potential features and solutions during product development, you must prioritise high value, low complexity ESG issues in your sector as well.
No VC firm will penalise your company for not having figured out everything when it comes to ESG. However, the market, i.e., your customers may penalise you as the startup matures and the reputational risk increases. For instance, over 50% of Gen Z and millennial consumers would boycott a company for not being eco-conscious.
4. Measure: What you measure depends on the business stage you’re in. It could be retention rate when you are trying to find product-market fit or monthly active users, as you scale up.
Applying the same line of thinking to ESG data, it is important to determine the one to three metrics that matter for the business stage your startup is in. For instance, tech startups could begin by focusing on data privacy and diversity metrics. It is important to note that the chosen metrics should also be something in which the next set of investors can find meaning as well.
5. Communicate: Bring your customers into your sustainability conversation and be transparent about ESG being a work in progress as you grow. Your transparency and relationship with your customers will be your first line of defence if there’s an unintended sustainability issue.
Don’t forget about your investors though! Add your ESG value creation story in your investor focused documents. If you can share some specific data linked stories, even better.
Remember: retrofitting a company’s culture to solve for ESG issues is much harder compared to embedding it in the company’s DNA from the beginning. Further, given the VC industry’s increasing focus on ESG, startup founders looking to raise funds must be able to anticipate ESG issues now and as the company scales up in the future!
Thank you for reading,
A.