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Venture Capital Slow to Take Up ESG Mantle

PRI report outlines barriers preventing VC signatories from incorporating ESG focus.

Venture capital (VC) firms are lagging other private markets investors in their efforts to instil strong ESG-related values in start-up companies, according to the UN-convened Principles for Responsible Investment (PRI).

To improve ESG performance and reduce risks among its VC signatories, a new PRI report sets out a plan to support future progress, and highlights existing guidance and initiatives.

“For responsible investment to flourish in the industry, understanding and knowledge about its application and benefits must improve at all stages of the VC funding spectrum and investment process,” the discussion paper said.

According to the report, many VC general partners (GPs) and early-stage companies believe ESG issues “are not material to the asset class” – largely because of the high failure rate (75%) of start-up companies. Further, very few VC firms have in-house ESG experts or resources to help them transition to a more sustainable approach to investing and engaging with investee companies.

There are also social-related issues within VC firms themselves that need to be addressed, the PRI said, noting that “the industry has a pronounced lack of diversity, and – particularly in Silicon Valley – a poor track record of sexual harassment incidents”.

A 2021 report by NGO Amnesty International highlighted that the world’s ten largest VC firms are failing on their human rights due diligence responsibilities, both in-house and for investee companies.

VC assets under management tripled between December 2016 and March 2021 to US$1.68 trillion, with firms gaining access to young, innovative companies, many offering sustainability-focused solutions.

By investing in companies at their earliest stages, VC firms can build ESG considerations into their foundations, such as addressing human rights issues and poor governance. Currently, climate-related issues are treated as “secondary” to social and governance, the report said, adding that VCs focused on blockchain and cryptocurrency tech companies should be more focused on the environmental impact of their investments.

“VC firms have an excellent opportunity to ensure that good culture and management of ESG issues are embedded into a company from the outset, ultimately driving improved outcomes for the business, later-stage investors, society and the planet,” said Peter Dunbar, Senior Specialist of Investment Practices at the PRI.

“Much of the industry focuses on providing solutions to some of today’s biggest problems, and investors can help to shape sustainability outcomes. However, that does not give an investor a free pass on ESG. Appropriately tailoring ESG in a way that adds value to early-stage companies is critical.”

The PRI aims to broaden VC signatories’ understanding of ESG and responsible investing this year by sharing examples of best practice, driving towards standardisation in reporting and also convening asset owners and VC firms to discuss ESG-related targets and expectations.

Making ESG a priority

Both individual firms and industry-wide initiatives are working to incorporate ESG principles into the industry.

Community-based NGO initiative VentureESG, which claims to have been “born out of frustration” that existing ESG frameworks don’t sufficiently account for the VC industry, aims to make ESG a standard part of VC firms’ due diligence, portfolio management and internal fund management.

Consisting of over 250 VC funds and limited partnerships (LPs) globally, the initiative is developing tools – such as a fit-for-purpose ESG framework – to help build in-house ESG resources and knowledge.

VentureESG has also been working collaboratively with the PRI to identify what the industry needs to best integrate ESG considerations into its DNA. The 104 VC firms and GP respondents to the PRI report were mainly PRI signatories or members of VentureESG’s working groups.

Japan recently saw the launch of its first ESG-focused VC fund, MPower Partners, led by Kathy Mitsui, formerly Vice-Chair of Goldman Sachs. New heads of sustainability have also recently been hired by Gobi Partners and 3one4capital, highlighting the increasing focus in this area.

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