Who cares about ESG?
A growing number of investors in the startup and venture capital (VC) ecosystem have finally started to emphasise environmental, social, and governance (ESG) related matters. There are good reasons behind it and the purpose of this article is to explain why that’s the case and what we at OpenOcean are doing about it.
I remember hearing the first time about ESG many years ago while working at a corporate bank. A person from the Markets Division tried to explain to the rest of us why yet another three-letter-acronym was going to be important. Most people in the audience were yawning and thinking “yeah, yeah, more regulation and rules to oppress us, blabla…”.
The thing is that this early ESG ambassador was absolutely right. ESG quickly became an important topic among institutional investors and eventually others in the food chain also started paying attention to it.
If you ask any sane person if he or she thinks that environmental or social factors are important, the answer is going to be yes. But, as Morpheus said, “there’s a difference between knowing the path and walking the path”. This is especially true in the investment world.
You might think that investors would change their behaviour just because “it’s the right thing to do”. Unfortunately that’s not always the case. Typically investors change their behaviour only when there are strong economical reasons for doing so. Fortunately, when it comes to ESG, investors have now realised that they can actually produce better long-term returns by investing in companies that not only are innovative and great but also have their ESG matters in order.
It’s becoming increasingly difficult, if not even impossible, to put together a VC fund without ESG being part of the strategy. The limited partner investors (LPs) investing in VC funds simply won’t invest if ESG is not your priority. The same applies to LPs when they’re fundraising. They won’t get money from larger institutional investors like pension funds or sovereign wealth funds unless they can be sure that ESG matters are in order.
Which brings us to the most important part of the ecosystem, i.e. startup founders who ultimately are the key drivers of value. If you as a founder want to raise VC funding for scaling your business, you have to be aware of ESG and understand what it requires from you.
Keeping our own house in order
If we as VC investors are setting demands for startups regarding ESG, then it’s fair to expect that our own house is in order as well. After all, a VC firm like OpenOcean is like any other company. We believe ESG is crucial for us to succeed in our mission, which is “to invest in and support the building of successful enduring companies, create long term value, and generate superior returns for investors”.
We’ve adopted the Ten Principles of the United Nations Global Compact and we support the Six Principles of United Nations Principles of Responsible Investment. We also adhere to the OECD Principles of Corporate Governance. Furthermore, we’re members of the European Venture Capital Association (“Invest-Europe”) and the Finnish Venture Capital Association (FVCA), which means that we support and act in accordance with their standards and guidelines.
All new OpenOcean employees are educated in ESG related matters and we talk about these important topics and principles regularly e.g. at our team offsite meetings.
Evaluating companies during the investment process
As a leading VC investor OpenOcean recognises the key role that improvement of ESG matters means for long-term value creation. Consequently our aim is to invest responsibly while following our investment strategy, which is to invest in data-intensive and delicious software companies in Europe.
We try to keep ESG matter in our mind during all stages of the investment process, but when a company enters the “Evaluation” stage there’s a formal Deal Evaluation Matrix that must be completed. The evaluation matrix contains various aspects that predict startup success, such as scalability, unit economics, market size, team composition — and these days also ESG.
ESG is also examined in the Due Diligence phase of the investment process (i.e. a term sheet has already been signed) and that’s when we really dig deep into the fundamentals of a company from a technical, financial, and legal viewpoint, often assisted by external experts and advisors.
Working together with our portfolio companies
In the early phases of a startup’s lifecycle there might not be too many ESG matters to worry about. Also, certain environmental aspects don’t apply to software products in the same way as to physical products. Nevertheless, the larger a company grows the more attention you need to put on aspects like human rights, labour rights, the environment, and anti-corruption.
We aim to set clear expectations on how to promote corporate responsibility within all our portfolio companies and to support them by providing guidance and tools. Most often we do this by being active members in the board of directors, which ultimately is responsible for delivering business objectives.
A recent development is that we have formulated an ESG questionnaire for our portfolio companies based on Invest-Europe’s ESG Due Diligence Questionnaire. Our ambition is to gather first responses during Q4 2018 and summarise the results in a new ESG section of our Fund Investor Report. Thereafter we will regularly request responses to the same questionnaire, which enables us to:
- Ensure that ESG matters are high on the portfolio company’s management agenda,
- Monitor the ESG status and progress across our portfolio, and
- Report to our LPs regularly on the ESG situation.
Conclusion
We’ve come a long way since the early days of ESG and that’s a very good thing for everybody in the startup ecosystem and for future generations on the planet. Today you can’t start a VC fund without having ESG as a natural part of your investment strategy. And as a startup founder you need to have your answers ready when VCs start to probe around ESG matters.
