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March 16, 2022

Private Equity and Environmental, Social, and Governance (ESG): Risks and Opportunities

By Corey Merrill, Partner, ESG

Executive Summary

  • Expectations around sustainability and corporate social responsibility are becoming increasingly ubiquitous in the lives of customers, employees, and investors.

  • Traditional private equity (PE) houses are increasingly considering ESG risks and incorporating opportunities for value creation across the due diligence and investment cycles.

  • While the focus on specific ESG activities varies, there is a growing consensus that a structured approach to risk assessment and reporting is necessary to both create new value and protect existing value.

Private equity sees value in ESG

The private equity industry continues to push through the ambiguity surrounding ESG criteria to navigate risks and discover opportunities to increase investment returns. While many traditional PE houses are taking the “wait and see” approach, those that are proactive about integrating ESG considerations into their due diligence and investment cycles are being rewarded.

Regardless of the approach, the confluence of risk mitigation, opportunities for growth, expected regulation, and customer demand make it clear that ESG will be playing a critical role in short- and long-term value creation.

ESG: The shift from “nice” to “need.”

Private and public companies alike have been taking stock of their ESG risks and ramping up their ESG strategies for some time. What was once considered a “nice to have” has become table stakes for companies of all shapes and sizes looking to meet shifting stakeholder demands. Therefore, the most progressive private equity firms have incorporated ESG considerations (i.e., risks and opportunities) throughout all aspects of the investment lifecycle (i.e., due diligence, investment, exit). As “The Expanding Case for ESG in Private Equity” report from Bain & Company highlights:

Firms recognize that consumers, regulators, employees, and sources of capital are energized by the notion that investors can and should use their economic clout to address the many existential crises we face as a society. Each of these groups is ramping up demands for change and, in many cases, rewarding it.”

While it’s clear that stakeholder demand is embedding ESG criteria into the investment lifecycle, there is still uncertainty surrounding how to measure and monitor ESG risk exposure and opportunities for growth.

A company’s ability to “tell its ESG story” has become synonymous with measuring ESG program maturity. Furthermore, the ability to take traditional business models and drive them towards sustainability-focused principles has been seen to unlock new business opportunities and create long-term value (i.e., loyalty) from consumers. This is especially true for the youngest consumers entering the period of their lives where they will have the most spending power.

To measure risk and develop new opportunities, PE firms are driving portfolio companies to:

  1. Identify or reassess priority ESG criteria (i.e., those which carry the highest impact for their industry); and
  2. Establish goals that can be measured and reported to internal and external stakeholders.

To accomplish this, an organization should adopt a structured approach that follows the most common frameworks and standards. Specifically, companies can increase the quality of their ESG program by adopting the most common standards and frameworks (e.g., Sustainability Accounting Standards Board (SASB) or Task Force on Climate-Related Financial Disclosures (TCFD)).

With a structured approach and quality reporting mechanisms, PE firms can continue to integrate ESG elements into portfolio companies throughout the investment lifecycle. By adhering to the most common standards, portfolio companies will be well positioned to comply with expected global regulatory changes.

Building and strengthening your ESG story

Whether you’re an acquisition target company or an established private equity house, a clear ESG strategy is needed to address shifting stakeholder demands. PE firms that have embraced the development of ESG strategies for themselves as well as their portfolio companies are poised to benefit from the changes on the horizon being driven by both stakeholders, customers, and regulation.

ESG’s value proposition may be clear, but a few questions remain as firms embrace ESG principles and build out their programs:

  • Are your ESG strategy and expectations clear for your firm, portfolio companies, and investment targets?
  • How have you integrated ESG into your value transformation processes for your portfolio companies?
  • Does your ESG story convey a mature ESG program?
  • By understanding where you are today in the ESG realm, you may be able to embrace the opportunities that are quickly developing.

If you are interested in learning more, schedule a conversation with our ESG team today.

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ESG
Private Equity