ESG thinking begins to permeate local startup ecosystem

Environmental, social, and governance (ESG) factors are starting to become a crucial part of sustainable investing and the European Union has been providing companies with a related regulatory framework. The concept will apply to all companies located or doing business in the EU, and new startups could emerge as the competition for the highest ESG scores intensifies.

By Ovidiu Posirca

Monitoring ESG performance should come easily and naturally for startups

In terms of environmental matters, a company can be assessed on its energy use and the way it handles waste and limits pollution. For the social component, what matters is the way in which a company engages with customers, employees, and other members of the community. On governance, factors such as company leadership, internal auditing, and shareholders’ rights are key.

Last spring, ESG disclosure obligations under the EU Sustainable Finance Disclosure Regulation (SFDR) became mandatory for asset managers, venture capital funds, private banks, and other financial market players, wrote Isabelle de Cremoux, CEO and managing partner at VC firm Seventure Partners, in an article for sifted.eu.

In short, ESG encourages companies of all sizes to incorporate sustainability into their operations. There are a number of different scoring mechanisms currently being used on the market. For instance, MSCI ranks firms on a scale of CCC to AAA, while Refinitiv provides scores from 0 to 100, according to CB Insights.

Ionut Tata, the CEO of Iceberg Plus, a startup consultancy, suggests that startups innovating by embedding green technologies or components into their core offer of products and services will likely find new investors, partners, client bases, and opportunities under this new framework.

“Discussions about the widespread legal and financial repercussions, newly imposed standards, as well as sourcing funds and cost-effective ways to implement required changes are at the forefront of how entrepreneurs and funds relate to environmental and social responsibility standards,” Tata tells BR. “Additional resources may need be redirected to meeting the new requirements, some KPIs may have to be reconsidered or postponed until new provisions are set in place, while pricing and cashflows may suffer alterations. Entrepreneurs and investors in sectors such as energy, transportation or agriculture should be the wariest of these changes,” he adds.

The focus on the sustainable transition comes on the backdrop of the health crisis, which has highlighted many social and health inequalities. The VC industry, which backs startups, can play a part in tackling some of these challenges under the ESG framework.

Representatives of professional firm PwC point out that VCs have the chance to help companies integrate ESG factors during their formative years, embedding ESG perfor-

mance into the culture of the company as well as its operating principles as the business scales.

Sustainability is gaining prominence in the purchasing decisions of younger generations. Companies’ efforts to become carbon neutral are also getting scrutinised.

Matei Dumitrescu, senior partner at startup investment fund Roca X, says that having specific EU regulation might set the bar for everyone in matters of standards. This could harness the creation of a new breed of startups.

“Startups require a different approach than a conventional company, so rather than adopting new policies, startups need to integrate them into their core from the very beginning. A startup will need enough room for maneuver in its early days, so an ESG framework will need to take this into account and not restrict or discourage any actions,” Dumitrescu tells BR.

He adds that monitoring ESG performance should come easily and naturally, alongside all other normal reporting that goes on between VCs and companies. In practice, without clear guidelines, such reporting can become a burden for most, discouraging them from pursuing improvements in this area.

SIGNIFICANT GROWTH IN CLIMATE TECH FUNDING

Roca X has seen two main approaches from investors following the sustainability trend. There is a focus on startups that solve environmental challenges, as well as one on investing in businesses with social returns such as education or healthcare.

“While classic funds and other asset management companies have had an easier time integrating new ESG policies into investment decisions in listed companies, the process for VCs has been much more difficult. Apparently, although many VCs are claiming that their policies are in line with ESG principles, in reality very few manage to monitor ESG performance,” Dumitrescu explains.

Nonetheless, a well-articulated approach to ESG could be beneficial for early-stage startups that seek financing or for older entrepreneurial firms planning to go public. For instance, VCs invested some USD 60 billion in climate tech between 2013

and 2019, of which USD 7 billion in Europe, according to a report by PwC. During this period, the compounded annual growth rate (CAGR) in the total capital deployed in climate tech stood at 84 percent.

There are 43 climate tech unicorn startups with valuations topping USD 1 billion, of which 30 are in the mobility and transport sectors.

In the short term, the industry that will be built around ESG policies will foster the development of companies that offer support services for the implementation of the legislation. The CEO of Iceberg Plus says this will include companies gathering data and doing environmental, social, and risk analysis, firms offering green transactions and statement services, companies ensuring green, high performance supply chains or suppliers of ESG monitoring and evaluation services, all of which will find new markets and client pools. “The challenge here, in my opinion, is being able to detach from trying to superficially adapt current workflows, expectations, and concepts to the new regulations. I think the process requires a fundamental restructuring of business processes and that, in all likelihood, it will deliver a stronger blow to rigid and robust organisations that are unwilling to implement such radical changes. One relevant comparison here is with the initial COVID-19 lockdown, where, across sectors, companies’ capacity to embrace radical changes was the main predictor of their potential to either thrive or fail,” Tata concludes.