Startups and ESG in the eyes of the investor

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In parts I and II of this series on startups and ESG, we urged young startups to expend the effort to understand the ESG pain points held by their potential corporate partners. By starting to think about their impact early, startups can learn to communicate how their product or business model can benefit both shareholders and external stakeholders. In this final article we take in perspectives of early-stage investors to help startups understand what matters to them and help them sharpen their message concerning their impact.

Investors understand that it is hard for companies to change existing practices. For this reason, promising young startups that can communicate clear and positive impacts stand to gain from interested investors looking to scale impact.

For early-stage startups, ESG can be overwhelming as a framework to start a conversation with investors. Startups can begin by characterising how their impact can be transformational, how they can deepen their efforts to capture impact, how to communicate their impact effectively, and how competing alternatives have struggled or failed. Angelica Morrone encourages startups to pick a Sustainable Development Goal (SDG) and work with it as an entry point. Startups must have at minimum a vision of how they will impact the world, and they must be sincere on wanting to be impactful. They must know who the beneficiaries of their impact will be and must understand the mechanisms of impact. A good way to approach this step is through the five dimensions of impact:

  1. What is the intended outcome?
  2. Who experiences the impact?
  3. How much is experienced?
  4. How much does the business contribute to that outcome?
  5. What are the risks that the impact does not happen as expected?

Startups and ESG in the eyes of the investor

Angel Investors who fund early-stage startups typically look to diversify their investment portfolio, allowing for a balance between investments that incorporate ESG criteria and those that do not. Generally, traditional investment criteria take precedence, such as capacity of the team and their passion to bring the idea to fruition. For Dario Caleffi, the key for startups is to make use of invested pre-seed or seed money to prepare for the next investment round, when ESG factors more commonly enter the discussion and strategy gets further developed.

Caleffi points out that sustainability motives in Business to Consumer (B2C) startups tend to have more appeal at this early stage if startups can cite the benefits of their idea or technology in ESG terms. Business to Business (B2B) start-ups face more challenges. This is where the search for strategic partners that share common ESG priorities becomes critical, and these priorities must be clear in the startup’s vision and mission.

For Morrone, startups can orient themselves by asking whether their impact will be deep or wide. Startups in the early stage typically do not have strong metrics to work with, but finding their place on these two axes can help them communicate their impact more clearly. An investor can help the startup grow so their impact scales proportionally.

ESG frameworks have received criticism for underwhelming if not deceptive outcomes on sustainability. A company’s ESG ratings may be high even if companies are not well aligned with SDGs because ratings reflect risks to a company’s shareholders and its bottom line and not necessarily the risks or benefits of the company’s activities for its external stakeholders. For this reason, positive screening of a company’s impact will be of growing importance in the future.

Value creation rather than risk mitigation is understood as the best way to leverage ESG frameworks for impact. Looking through this lens, the pendulum is swinging toward investors’ interest in a company’s positive or negative impact on the world around it. For Morrone, all future companies will incorporate ESG dimensions. Young startups often have an advantage in these terms, compared to companies with significant historical baggage tied up in their operations. Startups can focus on new opportunities and build positive change into their strategy right from the start.

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