The ESG index and how it affects our lives
Despite the importance of environmental and social issues, the prevailing perception so far has been that ESG considerations are the domain of large companies that can afford to allocate resources for focusing on future risks or corporate responsibility. Why does this perception has to change and why is it commercially correct?
By: Patricia Lahy-Engel
Entrepreneurs and investors play an important role in building a more inclusive, sustainable and egalitarian economy. ESG indices refer to three key factors in measuring the impact of investment: Environmental, Social, and (corporate) Governance. ESG criteria help investors better assess a company's future financial performance, both in terms of return on investment and in terms of risk.
The source of responsible investment
The practice of ESG investing began in the 1960s, when certain investors decided to exclude entire types of stocks or sectors from their investment portfolios, such as tobacco production, arms trade, or involvement in the apartheid regime in South Africa.
These issues are more relevant than ever. Climate crisis challenges such as rising sea levels and flood risk, fake news issues, privacy and data security, demographic change and regulatory pressures, are giving rise to new risk factors for investors. As companies face increasing complexity on a global scale, investors must reshape traditional investment approaches.
This is not a passing trend but a real paradigm shift. In 2018, Larry Fink, CEO of BlackRock (the world's largest asset management group currently managing more than eight trillion dollars) published a letter to the CEOs of public companies explaining that companies that do not adopt ESG considerations will not receive investment from BlackRock. It is estimated that a third of the financial assets currently managed in the United States are responsible investments, which are managed according to ESG criteria, and the issue continues to gain momentum, in Israel as well.
The perception regarding responsible investments
So far, the prevailing perception has been that ESG considerations are the domain of large companies that can afford to target resources to focus on future risks or corporate responsibility. Is ESG relevant to startups at their early stages?
Last December, Startups500, a VC fund from Silicon Valley that specializes in pre-seed investments, published a survey among portfolio companies. At the same time PitchBook published a survey on sustainable investments among venture capital funds. The findings show that startups understand the business benefits inherent in responsible investments and a growing number of VC investors are adopting ESG indices, motivated by various reasons ranging from risk management to reputation building. The question is not "if", but "how" to assimilate and how to measure them.
"Adopting ESG policy at an early stage of setting up a startup makes business sense"
The benefits of ESG investments for startups
Adopting ESG policy at an early stage of setting up a startup makes business sense. Beyond risk management, it opens up opportunities to reach new customer audiences such as Generation Y, which has strong social and environmental awareness. It enables building a more inclusive and diverse organizational culture that is aware of the aspirations and well-being of its employees and increases the chances of attracting and retaining talent in the organization. In addition, ESG policy helps with innovation processes because the integration of different cultures and worldviews in the work environment encourages creative thinking.
Social networks force managers to be transparent and responsible and to adopt a more progressive and responsible business approach. The big tech companies (Facebook, Google, Amazon) are under public scrutiny 24 hours a day.
What is true for established companies is also true for startups. These, too, will evolve (or aspire to evolve) into established companies with demanding boards, demanding employees and activist consumer bases.
Start-ups must be aware of this trend and act accordingly.
For founders and executives, this means more than just recognizing the importance of ESG, but also determining how to implement it within the company's goals. In practice, ESG policy must begin to be integrated into organizational operations and communicated consistently, both in the conference room and on social networks.
Most of today's startups were established after the great crisis of 2009, so the COVID-19 pandemic is the first major crisis they have encountered. In order to adapt to this new reality, early-stage ventures need to build resilience in their business models. Founders and executives of startup companies should prioritize pragmatic corporate governance with environmental leadership, social investment and awareness over models of growth at any cost that operate according to inflated private valuations as in the case of WeWork.
Startups need to examine their business models carefully to determine if they will be sustainable as the COVID-19 crisis continues and the next inevitable crisis strikes. They need to answer important questions: Does my company need to change in order to stay ahead of the trend, or to address a real need?