When Venture Capital investors invest in startups they are mostly looking for attractive financial returns. This has been the story so far where more and more investors are looking not only for companies with strong financial fundamentals but companies that provide social, environmental and economic impact in the regions where they operate. Investors are looking for startups to provide tangible community benefits such as job creation in low-income locations, corporate community engagement and the involvement of entrepreneurial investors in these fields.
This is referred to as ESG and is defined as E for environmental criteria, including the energy the company consumes, the waste it discharges, the resources it needs and the consequences for humans as a result. It also covers carbon emissions and climate change as a result of the energy and resources that every company uses.
The second element is the social criteria, which refers to the relationships the startup has and the reputation it fosters with people and institutions in the communities where they do business. Every startup manages labor relations and should promote diversity and inclusion as part of the social values.
The third element is the G of governance. It can be described as the internal system of practices, controls and procedures that the startup adopts to govern itself, make effective decisions, comply with the law and meet the needs of external parties. Governance is a vital element that enables not only compliance with the law but also enables the organization to transcend the times (McKinsey).
An example of a company that promotes the environment is Tesla Motors who designs and sells electric cars with zero carbon emissions. Tesla’s technologies and technological properties have changed the energy equation in the automotive sector. Venture Capital investors include DBL Partners, Vantage Point Venture Partners, Technology Partners, Valor Equity Partners, Draper Fisher Jurvetson, Daimler and Elon Musk.
Some elements to generate value through ESG according to McKinsey are the following:
- Increased sales: Having an ESG policy can enable companies to access new markets and expand in existing markets. ESG is an approach that builds trust between different stakeholders and can give startups access to approvals and licenses to continue their growth path.
Binance, the largest crypto exchange by traded volume founded in 2017 in China was banned in 2019 to continue its operations in the US and later also in the UK and Italy. Its governance model with little transparency, potential tax fraud, money laundering and insider trading have caused the platform to face regulatory scrutiny and is unable to continue its exponential growth in many markets. - Cost reduction: Effective ESG execution can help combat incremental operating costs, such as in raw materials, lower energy costs and water usage. One environmentally conscious company that has successfully reduced operating costs is Solar City, a provider of solar energy systems that deliver reliable power to homes and businesses. In recent years there has been an increase in demand for clean energy from homeowners and businesses, this coupled with the high cost of electricity, favorable incentives for solar energy systems have favored companies like Solar City. Some of its Venture Capital investors include: DBL Partners, Elon Musk, Draper Fisher Jurvetson, Generation and Mayfield.
- Reduced regulatory and legal interventions: Having ESG allows companies greater strategic freedom with less regulatory pressure and sometimes industry deregulation, subsidies and government support.
- Increased employee productivity: A strong ESG proposition can help companies attract and retain quality employees, motivating them through purpose and increasing productivity. The pandemic has shown that startups have a differentiated and probably more robust value proposition than traditional companies. Startups have taken on the task of nurturing their teams, motivating them and generally seeking their health. Traditional companies have been unable to understand the changing market dynamics and therefore have staff that is less motivated and sometimes less talented than startup staff.
- Investment and asset optimization: ESG can improve return on investment by allocating capital to more promising and sustainable opportunities. A logistics startup has incentives to build a fleet with electric and sustainable vehicles, as the return on its investment could be substantial. However, a traditional company that has an entire fleet of internal combustion vehicles may have little incentive to modernize as there is a significant cost and likely no payback value for the current fleet that could continue to operate for many years to come.
ESG is a new practice that is certainly here to stay. It is important that all startups take into consideration all the elements and put them into practice, this could allow them to increase the value of their operations. In addition, having a defined ESG strategy is becoming increasingly attractive to investors, which could help make the capital raising process easier.
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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