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Practical Magic

Every VC needs an education in ESG

It’s time for the venture capital community to bone up on environmental, social and governance issues.

Startup team brainstorming ideas

A startup team brainstorms ideas. Image via Shutterstock/Rawpixel

This article was adapted from Climate Tech Weekly, a free newsletter focused on climate technologies.

When it was founded roughly 23 years ago, Salesforce was unique in many ways, not just for its core product — software delivered only via the "cloud" — but also for its early embrace of what has become the Pledge 1% movement. It’s a model that designates 1 percent of the company’s equity, revenue, product and time to philanthropic causes. High-profile enterprise software companies — such as Atlassian, Slack and Twilio — were early to adopt this same approach. And Salesforce last month moved to make “sustainability” one of its core values.

In a similar way, I believe the initial public offering of trendy shoe company Allbirds, known for its early embrace of business practices centered on environmental and social sustainability, will mark a turning point for how ESG issues are considered in the life cycle of startups — not just by climate tech entrepreneurs, but the broader universe of up-and-comers.

To be clear, the Allbirds IPO was far from smooth. Because of the very real sensitivity over greenwashing, the company was forced by the Securities and Exchange Commission to stop using the phrase "sustainable initial public offering" as part of its messaging. But it didn’t negate the fact that Allbirds has embedded some very specific requirements into its operating model that every startup founder — along with the venture capitalists helping them get a leg up — would do well to study.

For starters, the company committed to report third party-verified GHG emissions across Scope 1, 2 and 3 before it started trading (which it did). Over the next two years, it has promised to take a number of other steps including having a validated science-based target across all three scopes within its first year as a public company, aligning its political advocacy with its ESG and climate goals, tying executive compensation to ESG metrics and reporting on diversity. To shape these policies, Allbirds is following a Sustainability Principles and Objectives Framework that was developed by an advisory council hosted by BSR.

People often forget you have to have your own house in order. How are you hiring and sourcing? What is your internal code of conduct? Who has ownership? What are your governance structures?

As one might expect — but is far from usual in the scheme of things — information about its climate strategy factored prominently in the company’s first quarterly earnings report, published Feb. 23. Aside from financial metrics, Allbirds offered specific updates on its Allbirds Flight Plan, including a 14 percent reduction on carbon footprint per unit in 2021, compared with 2020. The goal is 50 percent by 2025, and 95 percent by 2030. It even offers "guidance," as companies usually do for earnings. Alongside net revenue of between $355 million to $365 million (a 30 percent growth rate), Allbirds is projecting a 6 percent carbon footprint reduction per unit for its top 10 products.

When I interviewed the Allbirds head of sustainability, Hana Kajimura, during GreenBiz 22, she noted an increase in interest in these principles among the company’s supply chain partners. "What’s been really exciting to see over the last couple of years is this shift in the asks that are being made between brands and the supply chain, where I now have factories coming to me saying, ‘We have a science-based target for 2030, what are you going to do to help us meet that target because the materials you buy and use in your product count towards our target?’ It feels like we’re all finally swimming in the same direction."

It would appear, however, that many VCs are still treading water when it comes to their understanding of ESG. Sure, a growing number of funds focus on investing in ESG-centric startups. Far fewer members of the community are looking at how ESG factors within the core operating principles of the firms, but that’s beginning to change — and that’s a good thing, according to Ioannis Ioannou, associate professor of strategy and entrepreneurship at the London Business School.

"It’s easier for a startup, when you still have plasticity of the core values and the culture," he told me. "In some ways it is easier to integrate upfront, at the founding or early stages of the companies."

From a practical standpoint, VCs need to pay more attention to this issue as the public markets shift to value and expect IPO-minded companies to embrace sound ESG practices. And when it comes to climate tech, Ioannou said, many industries are ripe for disruption that favors entrepreneurs over companies locked into business models of the past, notably aviation, long-haul transportation and construction.

But it’s still early days, something that the founders of advocacy organization VentureESG are hoping to change. The nonprofit represents about 275 VC funds and limited partners — many members hail from Europe, although its U.S. presence is growing, with the likes of the influential 500 Startups on board.

A growing number of European VC firms are beginning to bone up on ESG expertise, noted VentureESG co-founder Johannes Lenhard, a University of Cambridge social anthropology professor writing a book about the social science of venture capitalism. 

London firm Atomico made headlines in February when it hired its first ESG director. Soline Kauffmann-Tourkestansky will work post-investment with firms that become part of the Atomico portfolio. Swedish firm Kinnevik, which focuses on fintech, food and health care, has embedded key performance indicators related to sustainability into investment evaluations. If a company fails to meet those KPIs, it won’t be eligible for a follow-on investment. 

Hannah Leach, partner with Houghton Venture (allied with the London School of Economics) and also a co-founder of VentureESG, said the mission is to better equip venture capitalists with the knowledge, tools and resources to better incorporate ESG principles into their portfolios. That means not just seeking firms that embrace this, but also rethinking their own internal processes. "People often forget you have to have your own house in order," she told me. "How are you hiring and sourcing? What is your internal code of conduct? Who has ownership? What are your governance structures?"

Another mission, according to the organization’s web site, is to prevent "ESG-washing" from creeping into the world of venture capital. To that end, it’s working on a framework of issues that are particularly relevant for this community. A working definition can be found in this white paper. One hallmark of whether a firm is serious is whether it has created a dedicated position or team. To that end, here are two big questions for startups: Are you ready to stand up to that scrutiny? And, can your lead VC backers also do the same?

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