As environmental, social, and governance (ESG) factors gain prominence in venture capital, it becomes essential to understand their crucial role in the value chain. The value chain of venture capital investment stretches from limited partners (LPs) to general partners (GPs) to startups. To achieve a comprehensive ESG approach in venture capital, each player in this value chain must work in harmony to ensure sustainability and responsible growth.
Limited Partners (LPs)
Limited partners, the backbone of the venture capital ecosystem, are the primary source of funds for venture capital firms. As institutional investors, family offices, or high-net-worth individuals, they invest in venture capital funds managed by general partners (GPs). LPs increasingly focus on ESG factors in their investment decisions, driven by growing concerns over climate change, social inequalities, and governance practices. Also, investors of LP funds are increasing regarding the practices of the funds they invest in and exigent practices.
The importance of ESG to LPs lies in its potential to influence long-term returns and risk management. By integrating ESG factors into their investment decisions, LPs can better identify funds with strong governance and risk management practices, which are more likely to deliver sustainable returns. In addition, many LPs face regulatory pressures to consider ESG factors in their investments or face scrutiny from stakeholders seeking greater transparency and accountability.
Amara Goeree, Sustainability Director, Schroders Capital:
“Staying conscious of the resource constraints that start-ups have to manage, we strongly encourage that founders and venture capital firms consider ESG integration and impact considerations as early as possible. Whether it is motivated by founders’ personal conviction or regulatory compliance and risk management today, in the medium term, all businesses are likely to move to an “ESG competitive advantage” mindset due to changing end-consumer and employee preferences and climate change. There is a clear advantage to early adoption. Measuring some business material, ESG KPIs will help guide the ESG approach and overall strategic decision making and please many investors.”
General Partners (GPs)
General partners, the venture capital firms managing the funds, are pivotal in driving ESG integration across the value chain. They have a fiduciary responsibility to their LPs to deliver strong returns while managing risks effectively. As the connection between LPs and startups, GPs must ensure that their portfolio companies adhere to ESG principles, as doing so directly impacts the financial performance and reputation of the fund.
For GPs, ESG considerations have moved from being a « nice-to-have » to a « must-have » component in their investment strategies. By incorporating ESG criteria, GPs can identify startups with sustainable business models, reduce the risk of regulatory penalties, and improve the fund’s reputation among investors and stakeholders. As LPs increasingly prioritize ESG, GPs not integrating these factors into their investment processes risk losing access to capital and diminishing their competitive advantage.
Valérie Gombart, CEO of Hi Inov:
« As venture capitalists, we believe in the power of innovation to transform our world for the better. ESG isn’t just a checklist or a ‘nice-to-have’ for us. It’s an integral part of our investment strategy and decision-making process. We’re not only investing in startups that have promising financial returns but also those that align with our commitment to a sustainable, inclusive, and ethical future. After all, creating long-term value means considering the broader impacts on our society and our planet. »
As the ultimate beneficiaries, startups have a responsibility to take ESG seriously. There are three possible approaches:
1. Embed ESG practices into their operations and growth strategies. By doing so, they can mitigate risks, improve stakeholder relations and business reputation, and strengthen their long-term competitiveness.
2. Improve the relative impact of their businesses on ESG topics. Resource-efficient companies that resell second-hand IT devices or optimize online services to use fewer physical resources may disrupt industries.
3. Offer transformative solutions that tangibly reduce the impact on environmental and social resources.
A strong ESG approach can help startups attract capital from ESG-focused investors and enhance their ability to scale sustainably. Moreover, as regulations around sustainability tighten and consumer preferences shift, startups prioritising ESG are more likely to thrive in the evolving market landscape.
Vincent Bryant, CEO of Deepki:
“ESG has gained prominence over the past few years, becoming a key component of business strategy, being integrated across all departments and operations, rather than a separate, “nice-to-have” stream. For all companies, whether startups or large corporations, a solid ESG strategy with tangible, measurable impact is not only a question of reputation, but of economic importance.”
Fred Plais, CEO of Platform.sh:
« Our ESG integration has helped us drive sustainability in our cloud infrastructure services. By using high-density computing within energy-efficient cloud data centres and minimizing clients’ carbon footprints with a location-based approach, we’re creating value for our company, customers, and the environment. Our venture capital partners have been crucial in supporting this direction. »
The Interdependence of the Value Chain
The ESG performance of each player in the venture capital value chain is intrinsically linked. LPs seek investments in funds that prioritize ESG, and GPs need to demonstrate their commitment to ESG integration to secure capital from these LPs. In turn, GPs are responsible for ensuring that their portfolio companies adhere to ESG principles, as their performance directly impacts the fund’s returns and reputation. Finally, startups that embed ESG practices into their operations are better positioned to attract investment from ESG-focused funds and grow sustainably.
Collaboration and transparency among all players are crucial to create a cohesive ESG approach throughout the value chain. This includes sharing best practices, setting clear ESG expectations, and monitoring progress on an ongoing basis. By working together, LPs, GPs, and startups can drive a culture of sustainability and responsible growth within the venture capital ecosystem.
The Role of ESG Reporting and Metrics
Transparent reporting and consistent ESG metrics are vital in driving ESG integration across the value chain. By adopting standardized ESG reporting frameworks, players in the venture capital ecosystem can effectively communicate their ESG performance to investors and stakeholders.
For LPs, reporting on ESG factors helps demonstrate their commitment to responsible investing and allows them to assess the performance of their investments more accurately. GPs can use ESG reporting to showcase their portfolio companies’ progress, strengthening their credibility among investors and improving their ability to attract capital. At the startup level, ESG reporting enables companies to track their performance, identify areas for improvement, and showcase their commitment to sustainability.
By adopting robust ESG reporting practices, venture capital value chain players can enhance transparency, improve decision-making, and ultimately contribute to a more sustainable future.
The importance of ESG in the venture capital value chain cannot be overstated. As concerns over climate change, social inequalities, and governance practices continue to grow, integrating ESG factors into investment decisions becomes crucial for all players. Through collaboration and transparency, LPs, GPs, and startups can work together to ensure a comprehensive ESG approach, fostering sustainable growth and long-term value creation.
By prioritizing ESG integration and reporting, the venture capital ecosystem can be transformative in addressing global challenges and driving a more sustainable, responsible, and inclusive future. As the world continues to evolve, the emphasis on ESG factors will only increase, making it an essential component of success for all venture capital value chain players.