Skip to main content

Practical Magic

Even private firms are facing closer ESG scrutiny

Sherlock Holmes

Shutterstock

When food delivery startup Deliveroo made its initial public offering in the early spring, it was supposed to be the London exchange’s biggest public debut of 2021 — after all, the Amazon-backed venture was seeking a market valuation of $12 billion. Instead, it flopped, with shares off 26 percent during the first day of trading. 

Central to the debacle were concerns over Deliveroo’s stance on shareholder voting rights and labor issues, an issue that has hung over Deliveroo for several years. The status of the company’s drivers was addressed among the risk factors in its IPO prospectus, and its decision to cling to the independent contractor model that has presented legal challenges for both Uber and Lyft — rather than treating them as employees — apparently spooked some would-be investors with ESG issues on their mind.

"Judicial decisions to retroactively reclassify riders would result in potential over our failure to comply with relevant employment and taxation requirements and associated obligations, which in turn could adversely affect our financial condition as well as our reputation," the prospectus notes.

Deliveroo’s fate underscores just how differently the private equity world and public markets have typically managed and responded to ESG disclosure, although the dynamics are shifting — thanks in part to forthcoming disclosure requirements in Europe. The IPO flop also should serve as a warning to entrepreneurs backed with funds from venture capitalists or private equity funds: Expectations are changing, especially for those seeking to issue an IPO or positioning themselves as an acquisition target. (Take heed, climate-tech entrepreneurs.)

"If you want to get ready to be publicly listed, you need to prepare for the public scrutiny," said Josh Brunert, ESG senior associate with London-based Apex Group. 

Expectations are changing, especially for those seeking to issue an IPO or positioning themselves as an acquisition target. (Take heed, climate-tech entrepreneurs.)

That reality will have an impact on both private equity firms and small and midmarket companies they’re backing, Brunert suggests. One key factor is the European Union’s new Sustainable Finance Disclosure Regulation, which requires a wide range of finance organizations — from pension funds to venture capital firms to insurance companies to banks — to disclose how sustainability risks are incorporated into their decision making. 

Among those risks are 14 core considerations ranging from carbon footprints to human rights policies. This regulation, in turn, will put pressure on smaller, private businesses to evaluate and be prepared to discuss how their strategies align with those criteria, Brunert said. Down the road, an even stricter set of reporting requirements, the Corporate Sustainability Reporting Directive, has been proposed and would cover all large companies that mean certain revenue or balance sheet metrics, or that have more than 250 full-time employees. (Two out of three metrics must be met.) That goes for U.S. companies with European subsidiaries. 

David Boekel, manager of impact reporting for audit firm RSM, said private companies face a crossroads when it comes to including climate, social and other non-financial issues as part of their corporate risk assessments. It’s important for managers to focus on identifying what’s material. "Embrace it as soon as you can, then you have the advantages of being more sustainable," he said. "Otherwise, it will be more of a burden." 

Knowing how to pivot

While disclosure in the U.S. is still voluntary, a similar shift is starting to stir with some private funders requesting more non-financial information from privately held companies in their portfolios — or those that want to be. Earlier this month, Boston-based venture capital firm Clean Energy Ventures published a carbon emissions calculator that’s now part of its application process and others have begun using similar tools. 

LB Equity, a New York-based private equity firm with a focus on beauty and wellness brands, considers issues such as sustainability, social impact, green chemistry and ethical sourcing as core to its investment criteria, according to founder Jay Lucas. He envisions a number of benefits from this approach. Not only will it strengthen LB Equity’s portfolio companies, Lucas believes it will help his firm attract better talent. "Internally, it will help drive performance of the brands. Externally, it helps in unanticipated ways," he said, reporting to the rise in pipeline since LB Equity began discussing its approach publicly. Brands don’t have to be perfect to garner the firm’s attention, but an intention to improve is required.

To move in this direction, the firm’s sustainability and social impact manager, Erin Knowles, developed a scorecard — incorporating tools such as the GRI and SASB frameworks — that LB Equity uses to screen potential investments for ESG factors. The firm examines issues ranging from raw materials extraction and production processes to employee satisfaction, diversity, equity and inclusion policies, and the extent to which environmental and social issues are used in decision making. "We focused on developing a tool that is intuitive and makes sense for a smaller company," Knowles said.

Karen Ballou, an LB Equity partner and CEO of one of its portfolio companies, Immuncologie, said that scrutiny inspired shifts in the production processes for her own firm, which sources its skincare ingredients from locations including France and Burkina Faso and was seeking to address the impact of its transportation footprint. It has centralized production in Maryland, where it uses recycled materials for its boxes and shipping materials. Immunocologie also supports an ongoing regenerative agriculture program for the roughly 150 tons of fruits it sources annually; all the water and natural resources are co-owned by the local community.

Immunocologie isn’t shy about telling those stories, even if the main audience right now is those selling its products, consumers and potential employees. But as calls for private companies to step up disclosure intensify, getting ahead of the curve could become a competitive advantage — not just for startups and entrepreneurs, but for the private money backing them.

"If you are trying to know how to pivot, you have to look at how you go forward and start to change," Ballou said.

This story was updated June 8, 2021, to clarify the scope of the EU's Corporate Sustainability Reporting Directive.

More on this topic