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April 19, 2021updated 20 Apr 2021 5:16pm

ESG for start-ups: What responsible investment means for tech innovation

Start-up founders increasingly view ESG as an important factor in their fundraising. But the venture capital industry is still determining what ESG means to them.

By Claudia Glover

Dispo is a photo-sharing app co-founded by David Dobrik, a YouTuber with millions of followers, and expectations for its growth potential are high. But when reports alleged that one of Dobrik’s associates had been involved in a sexual assault, Spark Capital moved quickly: the venture capital (VC) firm severed ties with the company and announced that it would take measures to ensure it would not profit from its $20m investment.

ESG start-ups

The majority of founders surveyed by 500 Start-ups say they have ESG policies in place. (Photo by Anel Alijagic/Shutterstock)

The announcement was seen as a departure for the VC industry, which has been accused of turning a blind eye to sexual harassment by founders and VCs. “This is an interesting precursor of what is to come,” Pam Kostka, CEO of All Raise, an organisation that supports female start-up founders, told The Information. “There are new standards that are emerging.”

As well as a turning point in the industry’s treatment of women, Spark Capital’s move is an indication that interest in socially responsible investing, often labelled ESG (environmental, social, governance) investment, is growing in the VC sector, as it is elsewhere. But, as in other corners of the financial ecosystem, what ESG really means in the context of technology start-ups, and how it should be applied to VC investment, are still being determined.

Growing interest in ESG among start-ups

ESG investment has been growing steadily since the 2008 financial crisis, as investors seek reassurance that their profits are not won at the expense of society and the planet. The number of institutional investors and private equity firms that have signed up to the UN’s Principles of Responsible investment grew 28% last year, and manage a combined $103trn in assets, according to the Investment Association. UK investors put around $1bn into responsible investment funds every month, according to management consultants Bain and Company.

The pandemic has increased the urgency of ESG investment: 55% of investors said the crisis had made ESG factors more important to their investment decisions, in a survey by insurance and pensions provider Aviva last year.

This urgency is felt by start-up founders too. In a survey of founders by US accelerator 500 Startups, 90% said they believe ESG practices have become more important since Covid-19. “It is unquestionably way more of a topic than it was even a year ago,” says Edward Lascelles, partner at UK firm AlbionVC.

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But what does ESG mean for tech start-ups? Most ESG investment frameworks have been developed to assess mature, listed companies that have large employee bases, extensive physical operations and supply chains, and formal governance structures – not start-ups with a handful of employees, no permanent office and no equipment.

Still, start-ups have a social and environmental impact like any other business. The 500 Startups survey identified a zero-tolerance policy on gender and racial discrimination, privacy protections, and carbon emissions reductions targets as relevant ESG measures for start-ups. It found that 62% of founders surveyed had policies such as these in place. Of those that did, 43% said that it had improved their fundraising efforts.

Not all founders are interested, however. Start-ups without ESG policies in place said they were “too early” (37%), do not have the necessary resources (31%) or have never thought about adding them (26%). One in five said, “investors don’t care”.

ESG frameworks for venture capital

VCs, meanwhile, are still figuring out how ESG should shape their investment strategies. A survey by data provider PitchBook last year found that VCs were no more confident in their understanding of how to define and measure the impact of their investments than they were in 2016. “ESG is a really slippery term and it means a whole lot of different things to a whole host of different people,” says Natasha Jones, early-stage investor at London firm Octopus Ventures. “There’s not that much regulation around what can be classified as ESG so there are lots of different strategies.”

The industry is beginning to develop its own ESG frameworks. Transatlantic VC firm Beringea has developed a set of guidelines called ESG_VC to help start-ups reassure investors of their credentials. “We decided to set out to build a measurement framework for ESG in venture capital, which would essentially give entrepreneurs the means to say, ‘Here’s my ESG benchmark’,” explains Henry Philipson, the firm’s director of marketing and communications.

Entrepreneurs at this stage in the creation of a business don’t have the time or resources typically to dedicate all of their focus to ESG.
Henry Philipson, Beringea

The benchmark includes questions such as ‘Do you measure your carbon footprint?’, ‘How many weeks of parental leave do you provide?’, and ‘What percentage of your suppliers have you screened for carbon efficiency?’ It is intended to be quick and easy for founders to complete, says Philipson. “Entrepreneurs at this stage in the creation of a business don’t have the time or resources typically to dedicate all of their focus to ESG,” he explains. “What we’ve tried to do is build something that makes sense for time and cash strapped businesses.”

As well as helping start-ups demonstrate their ESG credentials, VCs are making their own commitments to social responsibility. Balderton Capital, Europe’s largest VC firm, has published a set of Sustainable Future Goals, which are based on the UN’s Sustainable Development Goals. They include commitments to reduce emissions, tackle inequality, and preserve ‘data rights’.

Ultimately, however, VCs operate on behalf of their investors – or limited partners (LPs) – and their investments will reflect their clients’ wishes, says Lascelles. “In the end, you’ve got to realise that as VCs, we raise money from other people [and] our duty of care is to those people who give us money,” he says. “You can’t say to someone ‘give us some money to invest and we will give you a 20% return’ and then give it away to people because it’s socially good.”

Nevertheless, there is an evident impetus towards socially responsible investment and business practices in the technology innovation ecosystem, driven in part by the start-ups themselves. “Lots of start-ups are coming to us [and] saying, ‘We want to do better’,” says Octopus Ventures’ Jones. “There is a collective realisation that ESG isn’t just a nice thing to have anymore, it actually makes a significant amount of financial sense.”

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