What are key ESG considerations to attract venture capital and private equity? Find out in this podcast with CPABC’s president and CEO Lori Mathison and Kookai Chaimahawong, executive director at the Centre for Climate and Business Solutions at UBC. Part of our Coffee Chats with CPABC podcast series.
Innovative businesses and startups play a crucial role in addressing today’s major societal and environmental challenges. These enterprises are often backed by venture capital and private equity investors who evaluate ESG criteria when deciding where to direct funds. What aspects of ESG should businesses focus on as they seek to attract venture capital or private equity? Kookai Chaimahawong, executive director at the Centre for Climate and Business Solutions at UBC, shares her perspective.
Lori: How should startups seeking venture capital investment approach ESG?
Kookai: First, consider what ESG means for investors – I always say that ESG is a set of non-financial metrics, or a tool, that helps investors understand and evaluate financially material risks not typically shown in traditional due diligence like financial statements. Next, I recommend startups consider the ESG factors that matter the most for their businesses. In technical terms, we call this a materiality assessment. For a software startup, cybersecurity might be one material factor, while for a cleantech startup in manufacturing, worker health and safety would be a consideration.
Consulting a sector-specific materiality guide will help. I recommend the Sustainability Accounting Standards Boards’ sector-specific materiality maps and MSCI’s Industry Materiality Map. Then, the next step would be to complete a stakeholders analysis. Thinking about ESG can be overwhelming, but it’s not about disclosing everything – it’s about identifying what’s relevant and important.
Lori: That speaks to the risk side - to what extent do investors look at an ESG profile in terms of opportunity?
Kookai: For startup companies, especially in early stages, the risks aren’t as high compared to larger companies. Investors don’t expect early-stage startups to meet all ESG standards and reporting frameworks. You might be a two-person outfit in a garage, thinking of an idea to pitch to investors. At that stage, I recommend using ESG as a tool to show that you can identify opportunities. Startups often offer solutions for the ESG risks that larger companies or their customers face. By focusing on these solutions, you can demonstrate to investors that you know how ESG can be used effectively. As you grow, you can plan out ESG considerations that are relevant to your company and your industry.
Lori: How do ESG assessment criteria differ between venture capital and private equity?
Kookai: Private equity works with larger companies and the fund sizes are typically larger because they invest significant amounts into mature or acquired companies. Private equity involves more stringent standards and frameworks, because large private and public companies will be subject to certain regulations and disclosure requirements. These companies must consider a variety of ESG regulations that apply to them now or in the future. For example, if a company is going to go public in the U.S., they should consider their obligations under the U.S. Securities and Exchange Commission (SEC), which asks public companies to disclose Scope 1 and 2 emissions.
Private companies within the private equity portfolio should also be thinking about emissions from their operations to plan for the SEC’s requirements. As private equity funds are larger in nature, they may also have institutional investors, including asset owners, asset managers, banks, and pension funds. Banks and pension funds that invest in private equity funds ask private equity companies to disclose on ESG. Currently, the focus is largely on financed emissions, which reflect the emissions associated with the lending and investment activities of financial institutions. Private equity funds may be asked to disclose these emissions to the banks they work with. Similarly, larger companies must disclose emissions data to meet the requirements of their investors, who themselves need to report on these financed emissions to their stakeholders.
Lori: How can companies prepare for due diligence and investor screening?
Kookai: I recommend companies think about ESG due diligence beyond just reporting exercises to avoid a ‘check the boxes’ mentality. Consider this an important exercise for your company’s growth and preparation for the future. Investors typically send ESG-related questionnaires to companies, and while you aren’t expected to have a plan to address every item on it, demonstrating that you’ve considered different ESG factors is crucial. For example, even if your current carbon emissions are high, identifying this as an area to work on and having a plan to reduce emissions is essential to show to investors.
As well, investors have public working groups – one is the ESG Data Convergence Initiative (EDCI), which is led by investors in particular funds. The EDCI gathers investment funds together to simplify the ESG-related questions they ask of their portfolio companies. Their goal is to make it easier for companies to respond to questions, which in turn helps investors understand and manage risks. It’s important to remember that ESG is a journey for both investors and companies.
Lori: Are there any trends that you’re seeing in this space, BC or globally?
Kookai: Climate risks feel very real and will be a focus for most companies, as they are an investment risk. There are now more streamlined standards and frameworks to evaluate how companies can manage climate risk, including the Task Force on Climate-Related Financial Disclosures. Companies need to ask, ‘Do we have ways and mechanisms to identify and address the climate-related risks facing us?’ If your factories or supply chain are in certain areas, companies will be subject to inquiries from customers and investors about climate risk, and possibly about forced labour. Traceability will also become more important as companies consider where their components come from.
Lori: When it comes to ESG-focused startups, is there a success story that you can share?
Kookai: I’d point to Cascadia Seaweed. They are a BC-based company that manufactures seaweed-derived products for crop and cattle farmers, and they recently raised a successful round from impact investors. They succeeded because they were able to disclose ESG-related data, showing their current emissions and plans to improve in the future. They demonstrated that they were doing much better than incumbents, and that their actions were impactful in terms of performance and quality. To me, this highlights how ESG can be part of growth stories rather than just risk mitigation.
At the Centre for Climate and Business Solutions, we support small and medium-sized companies, including startups, in meeting climate goals. This includes understanding their Scope 1, 2, and 3 emissions. It also involves conducting lifecycle analyses – that is, understanding the carbon emissions produced from your materials used in manufacturing, all the way through to the product’s disposal, as well as how your product may be more sustainable than similar offerings. We were able to work with Cascadia Seaweed on those areas.
Lori: If companies would like to take their ESG reporting or understanding to the next level, can they reach out to the Centre?
Kookai: Absolutely. As I said, we focus on the E side of ESG, helping businesses to understand carbon emissions and their supply chain; to complement that, I also recommend reaching out to The ESG Centre of Excellence, formed by the Ministry of Jobs, Economic Development and Innovation, which supports BC-based companies in meeting ESG demands and leveraging regional resources.
For more insight, check out CPABC’s collection of ESG articles and podcasts.
Lori Mathison, FCPA, FCGA, LLB, is the president and CEO of CPABC.
