Before and after investing in venture firms, some limited partners are looking more carefully at how general partners manage ESG risks internally and within their portfolio companies.
For Harvard Management Company, which manages the university’s $53.2 billion endowment, governance is the most important element of ESG, Michael Cappucci, HMC’s managing director for compliance and sustainable investing, said on a webinar hosted by the Principles for Responsible Investment last week.
While Harvard doesn’t expect all of the venture funds in its portfolio to ask for a board seat at their portfolio companies, “we do believe VCs should understand what role they have to play and have some sense of what good governance practice is,” Cappucci said. “If they’re not going to lead the charge, at least support those who are.”
Roughly 35 percent of Harvard’s endowment is invested in private equity, with a significant portion of that committed to VC funds.
Cappucci cited WeWork’s very public legal fight to remove its founder as a situation that every VC should try to avoid. “There were a number of less-than-best practices around governance observed in the company, which eventually led to a significant pushback by the public market investors,” he said.
GPs should start thinking through those issues before a company reaches the stage where it’s looking to go public, so that they can be managed in a more private fashion, Cappucci added.
As for ESG metrics, Harvard looks at just two kinds: GP-level diversity data, which its stakeholders are demanding, and greenhouse gas (GHG) emissions data. In 2020, Harvard became the first university endowment to make a net-zero climate pledge, so it needs to collect that data for its portfolio companies across all asset classes, noted Cappucci.
While the average tech start-up doesn’t regard ESG as high among its business risks, Cappucci said it’s become much easier now to gather GHG data than it used to be. Two or three years ago, you still needed someone with an environmental science background to help with that. Now there are easy-to-use online tools, some of them free, that can help companies calculate their carbon footprints, he said.
Focus on intention
For AP6, one of Sweden’s government pension funds, with about €6 billion in AUM, the focus is on “intention and how [GPs are] managing the inherent risks in the market and the verticals they invest in,” said Anna Grgic, ESG manager at AP6.
Because VCs’ governance structures and resources differ from those in private equity, they often manage sustainability matters in a less formal way than in the buyout space, Grgic added. Her fund invests only in unlisted assets. After initially investing in the Nordic countries, it expanded to the rest of Europe and then extended its reach to the US a few years ago.
Grgic said she’s looking at how VCs address sustainability issues as portfolio companies scale and how they support their founders during that period. That includes the questions the GPs ask when they take a seat on a company’s board.
Some VCs who serve on boards make sure ESG is regularly included on the agenda, while others work with founders to drive sustainability in day-to-day operations, she noted. Grgic also sees sustainability clauses related to climate and diversity, equity and inclusion (DEI) in some VCs’ term sheets.
In 2021, PRI released a due diligence questionnaire (DDQ) to enable LPs to evaluate the ESG processes and engagement practices of private equity managers. That ended up being integrated into a broader questionnaire by the Institutional Limited Partners Association, which gained support from CalPERS, CalSTRS and KKR, among others. Last May, the UN-backed organization said it would convene a group of LPs and venture-focused GPs to tailor the due diligence questions to venture capital.
This Friday, January 27, it will conclude a nearly two-month online signatory consultation project, titled “PRI in a changing world,” centered on key issues for the future of responsible investment, PRI’s purpose and the value it provides to signatories.
On the social side, Hamilton Lane wants to be sure sustainability is “an area of importance for GPs, especially on DEI and [is being used ] to help promote within the firm,” said Andrew Rich, who heads the investment team. Hamilton Lane manages and supervises $116.7 billion in venture and growth equity investments across more than 260 GPs.
Hamilton Lane is interested in how GPs build diversity through initiatives within their own firm and also within their portfolio companies. “We want to know if they have targets they look for or targets that that they engage with their companies on that they want to build towards,” Rich said.
The sole representative of GPs on the webinar, Molten Ventures general counsel Ben Robson, said assessing founders’ ESG stances can be challenging when start-ups are in sales mode and presenting the best versions of themselves.
Molten, formerly known as Draper Esprit, is based in London and is included in the FTSE 250. It often takes seats on the boards of its portfolio companies.
Cultivating a relationship with founders prior to a deal going to the investment committee “is vital to having any chance of success at the venture stage,” Robson said. “Our team is more aware of ESG aspects than they were a couple years ago and can ask those kinds of probing questions in a non-elevated IC pitch-type environment.”
Although questionnaires are unlikely to elicit true founder intentions regarding ESG, they can reveal whether a company has made inroads to put in place processes that demonstrate commitments to things like DEI and may even provide a track record to build on, said Robson, who heads Molten’s ESG working group.
“We’re not necessarily looking for a finished product,” he added. “In fact, it could be we’re seeing something that’s underperforming in this area and we believe we can help add value by coming in and helping them, providing there’s intent, to get to a different place.”
Most founders that Molten works with want to do more with ESG but have many competing interests for their time. “So having someone offer help and support is often very welcome,” he noted.
“Our function can be helpful and useful as building out some of the guard rails early,” he said. “Helping founders build consistency in board structures, board meetings and the board PACs is a starting point.”
Robson cited the support Molten has had from Venture ESG and ESG VCT, two initiatives from VCs that are pushing the industry on good ESG practices, with a focus on materiality.
Cappucci of Harvard said VCs “need to keep an eye on the long-term prize, which is realization of these investments. The goal is not to stay private forever, at least not in a VC-backed structure. [ESG reporting] is required more for public companies. It’s a compliance issue in Europe and soon will be in the US once the SEC adopts its mandatory climate rules.”
Even if an IPO is not the endpoint for a start-up, ESG transparency is increasingly expected by strategic buyers, too. “It is relevant to the ability to get liquidity and achieve premium multiples even if it’s not relevant to day-to-day revenue targets,” Cappucci said.