Traditionally, the decision on where to invest was predominantly based on the level of financial returns. But as the world continues to evolve, with investors setting up new standards, more criteria are being introduced in the decision-making process.
Today, an evaluation of how companies perform is measured based on the people around, their environment, and their responsibility. These sets of standards, known as ESG, have become essential factors in financial analysis.
With the impact of COVID-19 on global economies, many investors saw an intensified need to consider ESG strategies as a more sustainable investing approach. As a result, a lot of start-ups begin to catch up on the trend, in fact, more than 60% are already applying ESG strategies in their company structures.
Let’s dig deep into ESG investing and why it is essential for every start-up.
Table of Contents
ESG (Environmental, Social, Governance) refers to the three essential criteria for evaluating the sustainability of an investment. In other words, it’s the yardstick that investors, in particular Venture Capitalists (VCs), utilize to screen the companies for their social or environmental responsibility.
ESG investing examines investment principles intended to produce higher financial returns while creating or maintaining a positive environmental, societal, and governance impact.
So how does ESG investing work? The ESG investing companies direct their utmost attention to sustainability investing and its impact on society so that these standards will lead their decision-making.
Let’s take a look at the three ESG investing areas of focus:
The terms ESG investing and impact investing gained so much media attention, especially in recent years.
According to MSCI report, nearly $4 billion flowed into ESG funds in just the first three quarters of 2019. Statistics shows, that in 2020 investors increased their investment in ESG-focused projects four-fold, compared to 2019.
On the other hand, impact investing funds have grown exponentially in the past few years, increasing from $502 billion in assets under management in 2019 to $715 billion in 2020.
If you ever wondered if investors care about sustainability, these figures might just have answered that.
Impact investing refers to the strategy of investing in organizations and businesses that want to gain both financial returns and positive social and environmental impacts. It is mainly done through VC funds and closed-end PE.
However, there remains some uncertainty on what exactly defines a positive impact. The outcomes of impact investing vary as different investors use different metrics based on their objectives.
While ESG investing focuses on financial returns, impact investing focuses on it less and mainly on intent. Impact investing aims to make a considerable positive social/environmental effect with the investments provided.
At the same time, ESG seeks non-financial risks that may probably have a material impact on an asset’s value.
Depending on the sector invested in, impact investing may produce lower returns than ESG investing, primarily due to the compromises that investors make to help with earlier-stage ventures in less developed markets.
The benefits of implementing ESG are too much to be disregarded. Environmental, Social & Governance matters are constantly on the agendas of many large companies, and early-stage start-ups need to be adopting the same criteria to step up their sustainability.
Let’s take a look at some of the benefits of ESG investing for start-ups:
Investors are considering ESG as an essential factor in screening start-ups. ESG implementing start-ups are recognized as safe companies because they have a reduced risk of social retaliation, civil litigation, or state fines, making it easy to provide funding for green start-ups.
When attracting top talent globally, ESG policies are topping the charts! Research conducted showed that nearly 40% of millennials opted to work for companies that uphold and implement ESG strategies such as diversity, inclusion, sustainability, and other factors.
Businesses that are socially responsible increase their appeal to investors and gain more trust and respect than those that do not apply ESG policies. With the current threat of climate change and resource depletion, companies that do not comply with ESG strategies are at a higher risk of falling off with both societies and investors.
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Implementing ESG factors will surely boost your tech start-up’s income. In the same manner that investors are using ESG to screen start-ups, so are the customers. Increasingly, customers are opting to choose brands that respect social and environmental issues.
This will distinguish your brand from the rest, and more customers generate more profits!
Many investors believe it is more effective to implement ESG policies now more than ever. The spread of COVID-19 and the Black Lives Matter movement heightened the importance of incorporating ESG policies in large companies and start-ups.
In a survey conducted to understand how current global events (especially the Black Lives Matter movement) influenced the adoption of ESG by start-ups, nearly 66% of the responders highlighted the need to adopt ESG policies with more emphasis on inclusion.
When it came to benefits offered by ESG policies, 69% agreed that ESG would result in more sales, and 91% responded that it would assist in attracting and retaining the best talent for their companies.
However, 20% of start-up founders replied that investors don’t care about ESG policies, while 37% thought that ESG policies still needed more time to be adopted.
Fintech start-ups, some of whom resorted to Ukraine outsourcing for product development services, have always been regarded as the ideal companies for investment by most venture capital (VC) firms interested in fintech ESG.
However, a vast number of VC investors are gaining the attention of social start-ups, environmental start-ups, and those under the governance category.
This is due to the increase of awareness on diversity and sustainable and environmentally friendly solutions, such as carbon footprint calculators.
Investors that provide funding for green startups or social startup funding need to be sure that sustainability VC funds are always directed towards companies willing to uphold the ESG strategy.
In 2018, Bill Gates created a fund worth US$1 billion to support start-ups that fight climate change. Also, in 2020, the Kolkata Knight Riders invested US$1.3 billion directed towards clean water, climate change, and waste management.
In 2019, ESG investment increased to US$20 billion from about US$5 billion in 2018. ESG impact continues to set the stage for more ESG funds to be invested because people are increasingly becoming aware of the environmental impact of their daily activities, causing them to cut down on energy use.
Due to the large amounts of money being invested, VCs often demand ESG questions for companies they wish to invest in.
These include detailed reports on contribution to GDP, number of jobs created, number of women employed in white-collar roles, how it affects climate change, and can sometimes include the CSR strategy.
They will ensure that ESG is being implemented into the investment decision-making and portfolio tracking processes.
Here are some of the start-ups that attracted a large amount of investment recently:
Here are some VCs that support purpose-driven young companies:
The faster your startup will create an effective ESG policy, the more you will get in the long run. So here are a few basic measures you can start implementing right now.
If you want your business to be successful, why not adopt the ESG criteria in the current business environment? Failure to do so can be detrimental to your business as more people are becoming aware of the impact and benefits of ESG policies.
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