Environmental, Social, and Governance (ESG)

Reality, best practices, and misconceptions

This article was originally published on Misk.

If you’ve attended any finance or startup event in the last 2 years, you’ve probably noticed an  intensifying barrage of the words ‘sustainability’, ‘stakeholder capitalism’, or the catch-all holy grail ‘ESG.’ While these concepts, and in fact the terms themselves, are certainly not new, the world has been paying a whole lot more attention to these terms and acronyms.

Environmental, Social, and Governance (ESG) is a holistic operational framework that is used to identify a company’s material risks and growth opportunities in order to drive long-term commercial and sustainable performance. From trying to delve into what on earth ESG is to pouring over $40 Trillion ESG assets seeking the so-called “ESG Alpha,” the world of ESG is broad. While the public markets have been sharpening their toolboxes with recent disclosures and data transparency requirements, investors are starting to look towards their venture portfolios as the next target for their ESG makeover.

As a founder of a new startup, you may be wondering why incorporating ESG practices is important…at least in the early stages of planning. You’ve got other issues to worry about and need to focus on building and scaling a successful business, right? But here's the thing, incorporating ESG practices into your business early on can help you achieve these goals. In fact, it's becoming increasingly important for early-stage startups to consider ESG factors in order to differentiate themselves from competitors, attract customers, fundraise throughout the lifecycle of the company and improve their financial performance. Globally, we are experiencing a rapidly expanding capital base specifically earmarked toward companies that prioritize ESG. Moreover, there is a growing base of data and supporting content that suggests that customers and employees are the key instigators for startups to implement ESG strategies.

At VentureSouq we’ve gone through a well-documented journey into the implementation of ESG practices at the firm and portfolio levels. Until recently, we have lacked global standards to benchmark early-stage founders and investors. It’s only now that we’re seeing globally recognized bodies such UN PRI or industry associations such as VentureESG and ESG_VC that have introduced frameworks to work with. This marks an important turning point for the industry: we expect to see ESG expectations trickle down the value chain - from LPs to GPs and founders. We’re witnessing the region quickly catching up with the launch of initiatives such as the Saudi Green Initiative.

The founders are not the only responsible ones here. Our voice and contributions are also important beyond portfolio reporting. From company screening to holding a board seat, ESG becomes an integral part of portfolio construction and management.

With that said, there are two frequently recurring questions we get, which we would like to address:

Are Impact and ESG the same?

The short answer is, no.

ESG and Impact are different. ESG looks under the hood and analyzes a company’s operational practices regarding its social, environmental, and governance engagements with all its stakeholders. This can apply to any company, irrespective of its mission or product, and is often a reflection of how responsible the company’s leadership chooses to act. In contrast, the impact lens focuses on the products or services the company offers, screening for products that intentionally create long-term positive environmental and social outputs.

At VentureSouq, we have crafted an ESG framework that we use to dually operate at a firm and portfolio level. In addition to this framework we also have an investment mandate that focuses on ClimateTech. While there has been some confusion about its function, the mandate is not an ESG or impact fund. Our Climate Fund is a separate thematic venture specifically focused on a sector we believe to be transformational.
 
​​A brief note to investors here: the founders are not the only responsible ones here. Our voice and contributions are also important beyond portfolio reporting. From company screening to holding a board seat, ESG becomes an integral part of portfolio construction and management.

How can I kick off my ESG journey?

Based on the different ESG frameworks mentioned above here are some areas for you to reflect on:

Governance

Reflecting on how corporate governance is managed across the company, from your company’s code of ethics to financial controls. Ask yourself: How does the company keep the Advisory Committee or Board regularly updated on company performance and operations? Is this transparent? Is ESG a frequent topic discussed as part of the Committee agenda?

Diversity & Inclusion

Creating a diverse, inclusive work environment should be part of any company’s strategy. This part includes hiring diverse teams across levels and making sure that the company’s work environment makes employees feel comfortable and empowered. Are you tracking gender and minority diversity in your team across levels? Do you have policies related to anti-discrimination, diversity, and equal pay?

Legal & Regulatory

Your business or at least a portion of it is probably subject to specific local or national regulations. Regional stakeholders are constantly introducing new regulations for emerging industries including FinTech, ClimateTech,HealthTech etc. and it can be hard to keep up. How do you monitor developments in regulation and ensure the company is in compliance?

Environmental Management & Impact

Global warming is directly correlated to human actions, and each of us holds a responsibility to act and mitigate their own environmental impact. Reflect on the environmental footprint of your company and product. While carbon emissions are the generally known factor, it can also include waste management, circularity, and non-product operations. You can start by measuring your company’s carbon emissions (categorized into Scope 1, 2, and 3) and put some environmental policies in place regarding your product, team, and/or culture. And yes, this also applies to software-only companies.

Team & Working Environment

Your team is your most important asset. It’s important that you put both the tangible and intangible pieces of culture and work environment in place. You can start by implementing formal policies such as parental leave or remote work. If you’re further along this journey, you can begin considering what benefits you’re offering to your employees – from mental health to training, personal development, and climate action.

Data Security & Privacy

One of the worst nightmares would be for a user to find out that their precious personal data has been hacked or misused. This is not only a reputational risk, but a legal and product-related one as well. Make sure your data privacy and management policies are in place and available to all users in a transparent manner. Depending on where you are in your journey, you should  consider having one or more employees responsible for the security of your product.

Responsible Product Design

Take a holistic view of your product. Are there any factors or actors that can be impacting the accessibility of your product? Are all the steps and uses of your product clear to your users? Are there any intended or unintended negative externalities and if so, how do you address these?

Supply Chain

There are countless tools to monitor your supply chain, but are you aware of all the different stakeholders involved? Do you take into consideration social or environmental factors when choosing the suppliers you work with? Do you have a framework in place for responsible procurement?

It’s important to consider what areas of ESG are crucial to your business. If you don’t know what lens to use, you can start by searching for your industry in the SASB Materiality Finder.

Last but not least, there are two key components to remember in this journey. First, transparency: your ESG strategy should be accessible and understandable to your stakeholders. Whether you are just starting and communicating your intentions to your board and investors, or whether you are 5 years in and completed your first third-party audit and certification for your users, your strategy should be clear. Second, continuity: this is not a 3-week sprint, this is an iterative strategy for your company. You can choose to focus on some ESG areas one year and then push for other areas in the next one, but the aim should be to continue getting better at it.

We will get to a point in time when ESG principles are prescribed, not optional. Our view is that no founder or investor should wait for the rules to be set by others. Take it upon yourself to adopt purposeful ESG frameworks that are optimal for your business, and your stakeholders will respond.