ESG funds attempt to find their place in VC

These initiatives, once a niche strategy aimed at improving a firm’s public image, have been thrust into the spotlight after 2020’s historic social movements. Does the VC community know what to do with them?

ESG or impact funds – funds whose sole intention is to produce a desired environmental, social or governance outcome – may be missing the point of the ESG movement, Robert Pomeroy, chief executive and chairman of Horizon Technology Finance, told Venture Capital Journal.

“A fund that touts itself solely as being better than anybody else, because that’s all they focus on, is missing the point,” Pomeroy said.

“Socially responsible funds have been around forever, literally the ’70s and ’80s,” he added. “If that’s all they were, without fundamentals for investment, they didn’t do anywhere nearly as well as traditional venture funds.”

ESG has notably gained serious traction over the last year in alternative assets, with some of the world’s largest PE firms touting their ESG initiatives and emphasizing their continued importance.

The trend is catching on in venture, too. The advisory service Different Funds reported last fall that the number of ESG-focused funds is on the rise. Since 2015, the number of VC funds raised each year by ESG firms quadrupled, up to more than 40 in 2019. The amount of venture capital raised each year by ESG firms has similarly quadrupled since 2015, up to $2.4 billion in 2019.

But firms have various ideas about how best to establish the fundamentals of an ESG framework for investing. In Europe, where investors are a few years ahead of the US in terms of focusing on ESG, firms are still trying to define what a standardized framework looks like.

EU initiatives

In Stockholm, Wellstreet partner and fund manager Jessica Rameau is working with Northzone, EQT Ventures and Industrifonden to adapt the Sustainability Accounting Standards Board ESG framework for start-ups.

The approach looks at ESG through an accounting lens, measuring the cost of non-compliance to certain international standards. “We like customer acquisition cost and customer lifetime value, so why can’t we add ESG ratios to that?” Rameau said.

London-based Balderton Capital developed its own Sustainable Future Goals, which were informed by and structured around the UN’s 17 Sustainable Development Goals (SDGs). In Berlin, the non-profit Leaders for Climate Action (LFCA) claims to have convinced 30 VC funds, including Earlybird Venture Capital, Cherry Ventures and Picus Capital, to add a “sustainability clause” to their term sheets.

But conflicts remain around when in a company’s lifecycle is best to implement an ESG framework.

Early or late stage?

Writing in a guest column in newly launched affiliate-title New Private Markets, Apollo Global Management’s chair of impact investing Lisa Hall outlined how later-stage companies are impact investing’s “expansive new frontier.”

“The early days of impact investing were dominated by venture and early-growth equity deals, but for impact investing to reach new heights, I believe it needs to reach more mature businesses, and that’s where our focus is,” she said. “We believe later-stage companies have the potential to create more impact as a function of their scale. They generally serve more customers, sell more goods and services, employ more people and often hold leading positions in their respective markets.”

This is, at least partially, at odds with those European leaders seeking to standardize the frameworks for VC, who generally believe that baking ESG priorities into young start-ups is where they can have the most impact.