How a decade of ESG in venture is ahead of us

How come VCs have not yet caught onto environmental, social and governance principles, a massive trend in other asset classes from buyout funds to public equities?

I asked this question months ago and have since focused more and more on it in my research at the University of Cambridge. Looking closely and tracking the developments, there are some signs that ESG is in fact finally arriving in venture land.

More funds worldwide, such as 500 Startups, Antler, Pitango and Blue Future Partners, have announced specific efforts in this direction. Others, such as Obvious Ventures, Blisce or MMC, and on a portfolio level Balderton Capital and Atomico, are working on it with a slightly different spin, such as through a focus on B Corp as a way to combine profit with purpose.

VC funds are beginning to be made aware of ESG, and recent research by Different Funds is pointing in that direction, too. But we are only seeing the beginning of these actions.

Let me go through three reasons for this and how the industry is starting to slowly shift.

A framework is needed

To begin with, there is no adequate and specific framework for VCs to align their investment practices with ESG principles. For impact investors, a plethora of these exist, from GIIN’s various efforts to the Impact Management Project.

There is no framework specifically focused on ESG for early-stage investors. As a result, some funds have started to craft their own, such as Blue Future and Kindred Capital.

Developing such a framework is an effort that a group of VC investors around GMG Ventures and a new fund that is partnered with the London School of Economics, called Houghton Street Ventures, want to bundle.

Within their initiative, they are working on an open-source ESG framework and a standard set of metrics for portfolio companies to report against. The goal for them is to come up with a common process shared by a coalition of VC firms in which ESG performance of funds and portfolio companies can be analyzed and benchmarked in the years to come.

Hannah Leach and Denise Xifara, GPs at Houghton Street Ventures and GMG Ventures respectively, told me: “What we are seeing in the industry is movement in the right direction but also a lot of fragmentation. The ESG coalition we are working on attempts to forestall this.”

Within their initiative, they are working on an open-source ESG framework and a standard set of metrics for portfolio companies to report against. The goal is to create a common process whereby ESG performance of funds and portfolio companies can be analyzed and benchmarked in the years to come.

Wanted: role models 

Second, even if there are quickly going to be investment frameworks based on ESG principles, we still don’t have any role models of how to do ESG-aligned portfolio management in practice for VCs. Enter Cecile Blilious who is currently turning Pitango’s portfolio ESG-side-up.

Blilious said that migrating a mainstream venture fund such as Pitango into integrating ESG practices is a process that is done in three parallel tracks. This includes integrating ESG metrics into the due diligence process and training the investors to embed those as part of the investment thesis; drawing a new set of impact companies to apply and go through the process while integrating ESG into their company DNA; and looking into the existing portfolio of companies and helping them “migrate” into adopting ESG practices and metrics.

While there are some funds that are experimenting with some of these steps at the moment – such as Kindred Capital, Antler and 500 Startups – we are very much still at the experimentation stage in terms of practice.

The LP point of view

The last puzzle piece is LPs. Do they really care about ESG anyway? Susan Winterberg, who recently finished a two-year fellowship at Harvard’s Belfer Center, interviewed many of them on the matter for her report.

Following up on her report, she said: “While many LPs have publicly stated commitments to sustainable investing and ESG integration, this often is not translating into the selection and management of venture capital fund managers. The reasons LPs cite range from a lack of data to compare ESG commitments and performance of VC fund managers to a lack of bargaining power LPs have to influence the practices of venture capital GPs.”

So, for the LPs, the evidence is not necessarily enough yet to really put pressure on GPs and diverge from the strictly return-focused investing, but they are starting to feel the heat. Accepting the need to divest from fossil fuels and to increase diversity and inclusion along all axes are the first steps that is already standing on a broader LP base. From there, embracing a full set of ESG principles seems much closer.

Compared to six months ago, the pieces now are more in motion and new ones are added by the day. Individual efforts are beginning to align, pushed even further by a resurgence of related developments in climate tech, foodtech and cleantech more generally.

The Black Lives Matter movement is contributing to a rising awareness, as well, and to an extent even covid-19 might push the ESG agenda further into the tech and VC world.

It is too early to say that the next decade is going to be one of ESG for VC, but it looks like it will only become more important for the time being.

Note from author: I and other participants and attendees will be picking up all of the above points of conversation from portfolio management to LPs’ thinking at two ESG/VC-focused panels this week at the Allocate conference.

Johannes Lenhard is an anthropologist at the University of Cambridge and is writing a book about VC ethics and decision making as well as co-authoring another on DE&I. He can be reached at jfl37@cam.ac.uk.