Understanding ESG criteria and expectations is critical for attracting investment and complying with environmental regulations – but what is it all about, and how should founders be thinking about this as they build their businesses?

Founders face a flood of acronyms, but there is arguably none that’s quite as important as ESG.

ESG – which stands for “Environmental, Social, and Governance” – is a framework for understanding the impact that businesses have beyond the financial bottom line¹.

It is typically assessed through a set of metrics that consider every aspect of your organisation’s internal operations, from the environmental impact of manufacturing and shipping your products to the way you nurture your people and the governance policies that underpin your company.

But why is it so important, and what does that mean for your startup? Here are answers to four questions that we’re frequently asked by founders when thinking about ESG.

ESG has a complex, lengthy history starting in 2004 when the UN Global Compact published a report titled 'Who Cares Wins' ².

This report was a catalyst for two decades of innovation, particularly in public markets, as organisations began to examine the non-financial performance of companies.

Over time, these criteria trickled down into alternative asset classes, including venture capital. Recently, however, that trickle has become a torrent.

This prominence is underscored by the fact that the number of private equity and venture capital firms becoming signatories to the UN Principles for Responsible Investment – a UN-supported network of investors that works to promote sustainable investment through the incorporation of ESG factors – has grown rapidly in recent years. EY reported in 2023 that the number had increased fourfold in the last five years, reaching a total of 1,090 firms.

The translation of the public market approach to ESG into Private Equity and VC has been accelerated by growing concerns about the climate crisis, a heightened focus on social issues, and a related increase in regulation around environmental and social concerns. For example, nearly half of all managers of private equity funds in Europe now address climate change through ESG policies, showing a 13% increase between 2022 and 2023.³

Most founders will find that understanding ESG performance will become an increasingly important part of reporting to investors.

Some 84 per cent of asset owners globally said they were implementing or evaluating sustainable investment strategies in 2021,⁴ but it is also likely to become a critical part of your interactions with your employees and customers. PWC data suggests over 80% of consumers think companies should be actively shaping ESG best practices, with and 86% of employees saying the prefer to support or work with companies who care about the same issues.⁵

Let me give you two practical examples.

First, environmental regulations in the UK and Europe now require large organisations to be transparent about their emissions, including emissions from their supply chain. For example, the Corporate Sustainability Reporting Directive directly impacts companies based in the European Union that meet two out of three criteria; namely, more than €50m in net turnover, more than €25m in assets or more than 250 employees.⁶

The second important aspect is talent. There is a growing trend of top talent wanting to work with organisations that have a clear understanding of their ESG performance and a stated set of objectives for improving it.

At Beringea we’ve seen portfolio companies lose out on senior talent because they cannot articulate this mission and purpose. For those companies that can get a handle on this, it is a great way to recruit and retain top talent.

ESG is now a “need-to-have” for venture capital firms across the UK and Europe for three reasons:

First, investors are grasping the opportunity to enable their portfolio companies to leverage ESG as a growth opportunity⁷. When we surveyed ESG_VC members earlier this year on their priorities when thinking about ESG, value creation was the number one objective of their ESG initiatives.

Second, the regulatory landscape across the UK and Europe is making ESG an essential part of VCs licence to operate. For VCs that have raised funds from European investors in particular, complex pieces of financial regulation such as the Sustainable Finance Disclosure Regulation (SFDR) have placed a far greater reporting burden onto venture capital firms. In the UK, the recent introduction of the Sustainability Disclosure Requirements may have a similar effect.

Lastly, and related to the regulatory burden, there are the growing demands of limited partners (LPs), who are the investors in venture capital funds. These LPs – typically government institutions, pension funds, asset managers, and family offices – have taken an increasingly rigorous approach to understanding the ESG performance of their investments.

These are developments that are increasingly impacting founders as they scale, creating genuine advantages to moving early and adopting ESG best practice.

One of the first steps is to speak to your investors, who will often have some suggestions on how you can get started.

Next, lean into the various support networks across the innovation ecosystem. ESG_VC, Tech Zero, Diversity VC and others provide resources and support to early-stage companies looking to improve their approach to ESG.

Then, tackle ESG as a team. Bringing your team into the fold ensures that you empower your organisation to take ownership of an important set of issues for its future growth.

And lastly, don’t let perfection stand in the way of progress. This is still an emerging area in venture capital, so investors and entrepreneurs are going to make missteps. There is no expectation to achieve perfection overnight, so enjoy the experience of allowing your company to celebrate its strengths while giving yourself the freedom to learn, make mistakes, and grow.