Asset owners pushing VCs to up their ESG game

Venture capital (VC) is a relative latecomer to the ESG integration party. After all, measuring and reporting on environmental, social and governance risks is not generally a top priority for start-ups or early-stage companies with limited resources.  

But with institutional investors focusing more on corporate sustainability, and ESG disclosure requirements on the rise, VC firms are under pressure to respond.

Aware Super, a A$170 billion ($111.7 billion) Australian retirement fund, is seeing positive progress on integrating ESG principles among its VC managers. 

"ESG data collection and reporting capabilities are steadily improving, particularly in terms of greenhouse gas emissions data," Liza McDonald, head of responsible investments at the Sydney-based institution, told AsianInvestor.

She is also seeing the superannuation fund's VC firms show "strong commitment to incorporating ESG considerations across the investment lifecycle, and with an increasing focus on the impact of companies during exits".

"Overall, we're seeing ESG strategies being marked by strong internal frameworks and active engagement with portfolio companies."

Liza McDonald
Aware Super

"This extends to engagement strategies, including tailored ESG onboarding programmes for portfolio founders," McDonald added, "highlighting an active approach to fostering ESG principles within portfolio companies."

RISING ESG FOCUS IN ASIA

These observations seem to reflect a well-established and rising focus on sustainability among Asia-based investors generally, from Hong Kong's Exchange Fund to insurer Prudential plc – as well as an increasingly mature VC industry.

For instance, Malaysian state pension fund KWAP is seeking to build up its domestic venture and start-up ecosystem.

It seems only a matter of time before ESG practices become more common in the VC sector internationally.

Certainly, large institutional LPs (limited partners) now typically have net zero targets and expect every company to report scope 1 and 2 emissions, regardless of how early-stage they are, said Michelle Lamprecht, head of corporate affairs at UK-based Cambridge Innovation Capital (CIC), a UK-based VC manager.

Scope 3 reporting is also a requirement if they are in the manufacturing sector, and often investors expect to see diversity, equity and inclusion (DEI) policies, Lamprecht added.

"It's good [for VCs and their portfolio companies] to work towards that, but we're not there yet," she said, speaking during a panel at the British Venture Capital Association’s ESG Conference in London in June.

But progress is happening, with Europe seemingly setting the pace.

Emily Matthews, responsible investment and ESG manager at Oxford Science Enterprises (OSE), a UK-based firm that invests in spinouts at pre-seed and seed stage, said most ESG data requests she saw were coming from European investors.

STRIKING A BALANCE 

A major challenge for VC firms is striking a balance between the needs of their investor clients and those of their portfolio companies.

Lamprecht said CIC’s portfolio companies often asked whether and why they should be addressing ESG issues given their scarce resources – and, if so, how. “It seems [to them] like this huge topic and a lot of work.”

How can VC managers tackle this issue? Lamprecht had a few suggestions. For instance, explain how applying ESG best practice benefits their portfolio companies commercially.  

Fundraising is one example. Companies showing strong ESG performance will attract different investors – potentially even impact investors if they're demonstrably having a positive social or environmental impact, Lamprecht said.  

A BOOST FOR ASIAN VCs? 

Asian VC firms may be especially keen to attract more client capital amid sluggish regional activity.

Enhancing their sustainability credentials could help boost their appeal to LPs, especially European ones.

VC investment in Asia fell from $20.8 billion to $17.4 billion in the second quarter of this year (largely thanks to a heavy fall in China), while global VC investment reached a five-quarter high of $94.3 billion, according to KPMG’s Q2’24 Venture Pulse Report. 

Speaking on the same panel as Lamprecht, he explained: “In addition to our investment committee process, we apply an ESG screen, which more than 90% of the time doesn't involve asking the company any questions.”

This entails using Google to check for any policy violations or any outstanding claims against the company, and they can just fill in the gaps, Kaletsky said.