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ESG and Private Equity: Is the debate effectively over?

We've been in-market talking to private equity firms about ESG for several months. Everyone seems to agree that ESG is a hot topic. But, there is still debate about whether it's a passing fad ("marketing ploy" is something we hear from the more cynical) or a real lever in the value creation process.

Many studies have attempted to draw a correlation between diligent ESG management and better financial returns.

Studies like this, however, tend to lead to mind-numbing debates about statistical significance and correlation verse causation. In case your minding is heading down that path right now...

We believe the debate is effectively over. Not because of an analysis of financial returns, and not because it's a nifty PR stunt.

The debate about ESG and Private Equity is effectively over because all critical stakeholders in a PE firm's business have said ESG matters.

Let's break this down by stakeholder:

Private Equity Stakeholder What they are saying about ESG

 

 

 

Limited Partners

At this point, dozens of studies point out how much LPs care about ESG. In the interest of time and space, here are two from leading authorities:

  • Harvard Business Review study finds 90% of LPs factor ESG into investment decisions
  • Bain & Company study finds ESG-related risks and unwillingness to improve on ESG approach to investing are top reasons LP's walk away from investments in new funds

More anecdotally, every PE firm we speak to that is raising money says ESG is now a high-priority topic. A broad ESG statement about the fund's commitment to ESG may have worked in previous fundraises, but is not working now. LPs need to see a real commitment to ESG

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Your Employees

Portfolio Company Employees

Consumers

 

Again, dozens of studies confirm these critical stakeholders rank a commitment to ESG as important to decisions they make about working for/buying from/doing business with a company.

Stats from one study led by PwC:

  • 83% of consumers think companies should be actively shaping ESG best practices
  • 86% of employees prefer to support or work for companies that care about the same issues they do
  • 91% of business leaders believe their company has a responsibility to act on ESG issues

 

 

 

 

 

Portfolio Company Management Teams

Management teams are of course employees and consumers and, as we saw in the box just above this, care about ESG. But, we've heard from several PE firms we work with that their portfolio company management teams have another reason for focusing on ESG.

Many PE firms have portfolio companies that are vendors to large enterprise clients. These often publicly traded enterprise clients are requiring vendors to address ESG related issues. This often comes up at contract renewal, and takes the form of addendums to the contract that, at a minimum, ask the vendor to commit to tracking and reporting on ESG related initiatives. In years past the portfolio company might say something like "we are a small firm and don't have the resources to track/commit to these types of things."

We have first-hand knowledge of this talk track no longer be acceptable, and contract renewals being held up/at risk because of it. Smart management teams have recognized this trend, and are proactively working on addressing it. In most cases, they are turning to their private equity owners for guidance.

As this trend continues, we believe a clear and pragmatic approach to helping portfolio companies address this will be a meaningful differentiator for PE firms competing for deals.

Debates over direct correlation to financial returns, or even whether or not ESG is a "marketing ploy" for PE firms are irrelevant.

The pragmatic reality is that every stakeholder that plays a role in private equity firms making money has resoundingly said that ESG matters. Limited Partners that fund the business want to see real commitment to ESG. Your ability to recruit and retain top talent - both at your own firm and within your portfolio - depends on it. And, perhaps most interestingly, many of your portfolio companies need to address ESG in order to keep their most lucrative contracts.

The only real question left is how to address it. We'd love to discuss our pragmatic approach to operationalizing ESG across your portfolio. It is nowhere near as daunting as some make it seem.