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Can PRI bring ESG standardization to venture capital?

'About six or seven leading LPs' have joined an effort to create an ESG due diligence questionnaire tailored to the venture capital industry.

The Principles for Responsible Investment is recruiting investors to help develop due diligence expectations for venture capital managers.

The UN-backed body unveiled a due diligence questionnaire (DDQ) to help limited partners assess the ESG processes and engagement practices of private equity-focused managers last year. That project had backing from big names including CalPERS, CalSTRS, KKR and APG, and has been integrated into the Institutional Limited Partners Association’s broader DDQ.

“We’re trying to get a similar group of LPs and VC GPs together to tailor those questions to venture capital,” PRI private equity specialist Peter Dunbar told affiliate title New Private Markets. “We’re inviting signatories to participate and aim to publish something later this year. Given that many of the most successful VC firms are not PRI signatories, we are also in active discussion with some of them and we hope they participate.”

Dunbar added that “about six or seven leading LPs” have already confirmed their involvement in the group, but declined to disclose the names.

Venture capital managers have come under fire for their approach to ESG due diligence in recent years, with one report from Amnesty International accusing the industry of “turning a blind eye” to human rights issues. Peter Werner, co-chair of law firm Cooley’s global emerging companies and venture capital group, recently said that beyond dedicated social impact funds ESG is rarely a significant component of investor due diligence. However, a study on ESG transparency last year concluded that, while nearly three-quarters of venture capital firms did not mention any ESG considerations on their websites, they are beginning to develop relevant policies and methodologies.

Venture Capital Journal recently reported on a study that found VC firms lagging behind PE firms in ESG efforts. Consulting firms ITPEnergised and Orbis Advisory analyzed 122 VC firms and 155 private equity firms, looking for evidence that firms were addressing and implementing four ESG criteria: ESG policy, in-house ESG, pre-investment due diligence and ESG benchmarks. The consultants found that nearly three in four VC firms (72 percent) did not indicate any ESG considerations on their websites and just 10 percent satisfied all four of the criteria.

PRI’s Dunbar said it is important for VCs to think about ESG because they interact with companies at such an early stage. “The logic behind looking at VC is that it’s generally the first institutional money that goes into a company, so investors need to think a little bit more about how they send these companies off in the right direction,” he said. “But we also need to make sure that the requests for information from the GPs are reasonable, standardized – to the extent possible – and phrased appropriately. So we will spend some time discussing with both sides to make sure we create something that will have widespread buy-in to try to ensure high adoption rates.”

The PRI is in “early discussions” with ILPA to see if the pair can collaborate again, said Dunbar, who added that “including our private equity ESG questionnaire into ILPA’s broader PE DDQ was really important for us, as it allows it to truly become an industry standard.”

ILPA did not respond to a request for comment at the time of publication.

Some LPs have already developed ESG assessments for potential VC managers. Swedish pension fund AP6, which specializes in unlisted investments, updated its ESG DDQ last year to cater for venture capital firms.

Anna Follér, AP6’s head of sustainability, said it was “really helpful to adjust the DDQ because of the specificities of venture – generally minority stakes in small companies often with innovative business models or technologies, as opposed to bigger buyout stage deals. So the revised version has created a much better base for discussions with venture managers.”

The results of AP6’s ESG DDQs form the basis of its in-house ESG scores for asset managers. Follér did not disclose the questions in the VC version, but said managers that scored highly were those that think about sustainability trends when sourcing deals and working with entrepreneurs, rather than simply addressing short-term ESG risks.

“With venture, it’s even more important to consider what the world is going to look like in 10 or 20 years time – what kind of transition shifts are on the horizon in food and agriculture, transport, energy, etcetera,” she said. “You can argue that that’s more relevant for these smaller companies than for more mature companies, so we want to see managers thinking about that.”

Follér added that the adjusted ESG DDQ also seeks to address how managers support entrepreneurs to “formalize ESG in a relevant way at a relevant time in the scaling process of the company,” and how they collaborate with co-investors to encourage companies to develop their ESG practices.

This article first appeared in affiliate publication New Private Markets