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What is the role of ESG in private equity value creation?





Consideration of ESG factors is not new to private equity. While in the past firms predominantly integrated ESG factors from a risk management perspective, ESG is now widely seen for its potential to drive value creation.

A study by Deloitte found that portfolio companies that have a 10 point higher ESG score are associated with approximately 1.2x higher EV/EBITDA multiple. It also found that companies that improve their ESG score by 10 points, on average increase their EV/EBIDTA multiple by 1.8x.

From pre-investment to exit, there are opportunities for PE firms to integrate ESG factors across the investment lifecycle, helping to identify and mitigate key risks, identify opportunities for growth, access new markets, enhance efficiency in business operations, and maximise financial returns, and ultimately, exit value.

Here are three ways integrating ESG into your strategy can create value.


1. Improving brand, reputation, and employee retention

Companies with purpose-led brands and strong ESG credentials have more motivated and engaged employees, higher productivity, better retention rates, and increased market share gains. A survey of more than 16,000 people conducted by IBM also found that 68% of people are more likely to apply for jobs with environmentally sustainable companies.

By comparison, companies with poor brand images and a lack of concern for ESG issues are likely to struggle to attract and retain talent, and may suffer commercially as a result.

In 2010, Boohoo’s share price dropped by 46% after controversies related to poor working conditions and modern slavery allegations were revealed. Meanwhile, PE giant Blackstone suffered significant repercussions when one of its portfolio companies — Packers Sanitation Services Inc — was found to be employing children as young as 13 in its meatpacking facilities. The company was fined $1.5m and Blackstone was asked to explain and improve how it manages risks to investors and workers.

Compare these to the ongoing success of a company like Patagonia, valued at around $3bn, which has a strong ESG agenda and recently committed to donating all its profits to combating climate change.

Ensuring portfolio companies have strong governance procedures in place and that leaders are responsible and accountable for the company’s ESG strategy may help to mitigate incidents that may damage the brand and reputation of the business.


2. Cutting costs and increasing efficiencies

Companies that integrate ESG and undertake changes to optimise the efficiency of their operations are likely to cut costs whilst also reducing emissions and other environmental impacts. For example, by adopting an innovative AI route optimisation software system,ORION, package delivery company UPS reduced its annual fuel use by 10 million gallons per year, and cut its carbon footprint by 100,000 metric tonnes per year – equivalent to removing 20,000 cars from the road. At full deployment, UPS expects the system to help the company reduce its operating costs by $300-400 million a year.

Some food producers are also now switching to more environmentally friendly fertilisers (e.g. green ammonia made using renewable energy rather than fossil fuels) to minimise their environmental impact and satisfy regulations to reduce supply chain emissions.

Switching to more sustainable technologies and approaches may also help to lower the cost of capital, improve operating margins, and facilitate access to new markets. Tesla for example, effectively positioned itself as a leader in sustainability and attracted investors interested in low carbon technologies helping it to raise capital at competitive rates and improve access to capital markets. Tesla also positioned itself to align with the global energy transition, becoming the world’s leading supplier of electric vehicles (EVs) for several years, with the largest overall market capitalisation to date.

By contrast, companies with poor operating practices that lack sustainability and/or innovation can suffer commercially and reputationally. Around 2016, electronics giant Samsung fell behind its competitors by failing to switch its operations to using renewable energy sources and producing a comparatively weak set of carbon reduction targets. The company was also criticised for failing to publish a list of its suppliers.


3. Managing regulatory risks

Companies and investors are facing ever growing pressure to comply with increasingly rigorous and mandatory regulatory standards. Establishing an ESG approach and prioritising sustainability reporting can help to ensure businesses are able to effectively fulfil relevant regulatory requirements and are ready for any future changes. This in turn can help them address investors’ requirements, manage risks, improve their reputation, and ultimately increase their market value.

Regulations like the TCFD (Task Force on Climate-Related Financial Disclosures) are driving larger companies and financial institutions to publicly report their climate-related risks and opportunities to ensure investors have better quality and more comparable information on the identification and management of climate risk. Many larger companies will soon have to comply with the EU’s CSRD (Corporate Sustainability Reporting Directive) and CSDDD (Corporate Sustainability Due Diligence Directive), while some financial institutions may need to fulfil the requirements of the EU’s SFDR (Sustainable Finance Disclosure Regulation) or the UK’s SDR (Sustainability Disclosure Requirements).

Meeting these requirements will require firms and businesses to source new forms of data (e.g. on financed emissions and exposure to climate risks), and perform new assessments and analyses (e.g. climate scenario analysis or scanning of supply chains for human rights issues). Those with an established ESG process in place will be able to adapt quickly and efficiently to new requirements while newcomers to the space may struggle to keep up, and even fall foul of regulations (e.g. on greenwashing or human rights) with potentially significant financial and reputational implications.

Similarly, companies who prepare for incoming legislation such as the banning of single use plastics, for example by switching to more sustainable alternatives, can avoid the costly and disruptive impacts of having to quickly adapt products and packaging throughout their operations and supply chains. They may also benefit from increased brand reputation.


How we can help

GPs have an opportunity here to build ESG into the strategic value creation process of private equity strategies, and we can help you to do that.

PE firms also have a pivotal role to play in supporting portfolio companies to understand and integrate ESG into their businesses, helping to drive value creation. Danesmead ESG can help GPs to provide support to portfolio companies in the following ways:

Implementing strong governance protocols.
Appointing senior level ESG responsibility.
Setting ESG priorities and objectives.
Developing and monitoring ESG KPIs.
Assisting with the development of ESG frameworks and tools.
Aligning with ESG standards and protocols.
Developing ESG roadmaps, action plans, and strategy.
Providing materials, guidance and training on best practices.
Preparing companies for exit or IPO.

Please get in touch to discuss how we can help.


Harriet O’Brien, ESG Consultant, Danesmead ESG
Harriet O’Brien helps organisations and investment managers implement and integrate ESG. Prior to Danesmead ESG, she worked at Arup, where she helped corporates, investors, and cities to understand their ESG risks and opportunities and embed long-term strategies to manage them. Harriet received an MSc in Environmental Technology, Energy Policy from Imperial College London, an MA in Political Science, International Public Policy and European Studies from UCL and a BA in Spanish from the University of Bristol.

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