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VC firms should seize the opportunity to drive ESG change among start-ups, says PRI report

The companies that venture capital investors back have the potential to have significant positive and negative impacts across the spectrum of ESG issues as they scale up – including privacy violations, human rights issues, poor governance and climate-related risks.

That’s according to a new on PRI report on the interplay between venture capital activity and ESG, which outlines how VC firms are adopting ESG considerations into their activity and the work still needed to drive adoption further.

The report says that managing these issues at an early stage of a company’s growth is key – evidence of failing to do so can be seen in recent high-profile ESG issues at VC-backed companies, such as Uber.

ESG incorporation in VC is nascent, but the level of interest is growing. Incorporating ESG considerations into a company from its earliest stages can be a vital part of affecting long-term systemic change on key issues. A company should not be exempt from managing ESG risks and opportunities just because it’s an early-stage investment, says PRI.

The report also says that the venture capital industry must improve its practices on a range of ESG issues. Notably on diversity, equity and inclusion, both at the GP level and at investee companies.

The industry has a pronounced lack of diversity, and – particularly in Silicon Valley – a poor track record of sexual harassment incidents. Although many firms are actively taking steps to address these issues, and industry-wide initiatives have also emerged, more progress is needed.

Responsible investors can also do much to ensure that companies have the right culture and policies to grow responsibly from the outset, for example by adopting a Code of Ethics.

Likewise many VC firms treat environmental considerations as secondary to social and governance ones. VC activity, especially that in blockchain and cryptocurrency technologies, has a notable impact on climate and this must be addressed.

More traditional ESG incorporation methods tailored to venture capital could be employed as companies grow through later-stage funding rounds.

Part of the underlying reason for the nascency of ESG within the VC space is that the venture capital model itself presents serious barriers to adoption. Many stakeholders question the value of ESG incorporation across a portfolio where up to 75 per cent of start-up companies fail, and a growth-at-all-costs mindset is dominant, seeing huge amounts of capital invested into companies that struggle to be profitable. As a result, venture capital firms are reluctant to invest in dedicated ESG headcount.

There is a significant level of investment in venture capital currently, and VC firms often struggle to differentiate themselves. Top venture capital GPs compete for start-up founders rather than LPs – if founders begin to prefer venture capital GPs that can partner with them to improve their management of ESG risks, then having responsible investment credentials may become a competitive advantage for venture capital firms.

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