Making sense of ESG
By now most people in the venture capital (VC) ecosystem have stumbled across the three letter acronym ESG. Many will be able to explain that the letters stand for Environmental, Social, and Governance — and that these are important matters, not just from an ethical perspective but also from a business perspective.
However, when probing further into each letter, things can get somewhat obscure. Sure, it’s easy to name a few trending topics within each category (and almost always Carbon footprint and Diversity will be mentioned), but there’s much more depth behind each letter. There is however a balance to be struck, because it’s easy to get too deep into the weeds within a category, making it difficult to focus on what really matters.
As VC investors in software startups that build unique data solutions, we’ve tried to make sense of ESG by focusing on a few key topics within each ESG category as we work with entrepreneurs. These are topics we’ve determined to be impactful within our field and we hope to understand them already before making an investment. They are also important and tracked once we’ve made an investment and start working closely with the company towards its success.
We ensure that ESG is discussed in all boards where we have a board seat, and each year we survey our portfolio companies in order to measure what development has taken place. Ultimately our purpose is to ensure that ESG is part of the management agendas in all of the companies we work with.
Given the fact that we work solely with software companies, one might hastily think that Environmental is the category we focus the least on, but that’s not the case. It’s often thought that since software companies don’t have any physical manufacturing or supply chains, there’s not that much to be done in order to reduce the carbon footprint. That’s however not the entire truth.
An often forgotten topic is the ever-increasing energy consumption of complex task executions. The amount of power consumed by machine learning tasks is staggering and the exponential development could cause serious sustainability challenges in the future. Fortunately, smart software solutions can also save energy, e.g. by cutting infrastructure costs, which is the case in Sunlight.io, a Cambridge-based startup we recently invested in.
That being said, we do ask if our companies have an Environmental Policy in place and how they see their resource requirements and consumption going forward. We also want to understand how they travel and utilize videoconferencing and other modern digital collaboration tools.
The Social category is very important for us and subsequently there are several questions in our annual survey addressing it. For example, we ask the company if they have the following policies in place:
- Health and Safety Policy
- Policy supporting anti-discrimination and potential migrant workers
- Policy supporting diversity
We also want to know if there are systems in place for identifying and addressing Health and Safety issues the company might face, or that the personnel might come across in the work or outside the office.
Furthermore, we ask what the percentage of women is in the company’s management team and in the board, how many different nationalities are represented in the company, and what the percentage of different age groups is.
Naturally we’re interested in learning about any interesting or tricky situations the company might have faced, and how those issues were resolved. Anonymized case studies can also be used for sharing knowledge and lessons learned across our portfolio.
Pay equality is an important aspect and this is also something we look into. We also want to understand what kind of insurances the company has in place and for whom.
The younger a startup is, the less they’ve typically paid attention to corporate governance. That’s understandable, but unacceptable as the company grows and the number of stakeholders increases.
As A-round VC investors, we are often the first institutional VC investors joining the company, which usually means that there are several basic things we need to put in place together with the company, starting from regular board meetings and systematic reporting.
In general, within the Governance category, we’re focused on what kind of policies the company has implemented and how they are enforced. Thus, we ask if the company has e.g. the following policies in place:
- Good Corporate Governance Policy
- Code of Conduct
- Policy / Guidelines for Information Security
- Policy on Corruption or Illicit financial actions
We are also interested in knowing if the company has formal employment contracts for everybody, if they’ve taken steps to ensure GDPR compliance, and whether or not there’s a whistleblowing system in place for the personnel to report e.g. bribery, corruption, money laundering, discrimination, or harassment.
It’s easy to see that each category of ESG is a world of its own and as such, each category can be expanded into a vast and complex realm. While a certain level of detail is needed to understand the facts, too much detail and complexity can make it hard to see the forest for the trees.
Once we’ve identified the topics that really matter in a particular case, it’s important to measure the development at regular intervals. We do it annually with an ESG questionnaire across our portfolio.
While we don’t pretend to be the world’s foremost experts on ESG, we have tried to take a systematic and serious approach to treating it when considering new investments and when working with our portfolio companies. The reason is obvious: startup teams that promote corporate responsibility, take diversity and equality seriously, and treat their employees well tend to deliver superior results.