Insights series / 19 April 2021
Venture Capital & ESG
ESG frameworks (at least at some level) have been around for some time in the Private Equity space. However, we have seen a continued move away from ESG being a box ticking exercise as part of the side letter process to a critical area of focus and part of the investment process for investors, managers, portfolio companies and consumers.
Venture Capital is sometimes perceived as a relatively slow adopter of ESG frameworks when compared to other private equity strategies such as buyout…but there is a good reason. Venture Capital Managers generally have smaller teams with more limited resources as well as immature portfolio companies lacking the means to adopt best practice in ESG. Venture Capitalists would argue however that ESG is built into the investment process; it’s just not explicit.
With the market beginning to show correlation between ESG implementation and high-performance the industry is beginning to adapt:
- Investor Level – during the fund due diligence process some investors will avoid Managers that do not implement ESG into (a) their investment process or (b) the running of their own business (for example by having a clear Diversity and Inclusion Policy). They will simply exclude the Manager. Consequently, we are seeing Venture Capital groups step up their ESG efforts and put in place clear frameworks for delivery and reporting of ESG metrics.
- Fund Manager and Portfolio Company Level – Venture Capitalists would argue ESG has always been part of the investment process, but this is now far more explicit in investment decision-making. Not only does a robust ESG framework help manage risk; there is also clear evidence that portfolio companies with good ESG scores outperform others. That is not to say that VCs only invest in companies that already have ESG policies in place but that they are also looking for companies that have an ESG ambition and vision. Critically, in the Venture Capital space early-stage companies that imbed ESG principles will be better positioned for IPO and therefore generally more attractive.
- Consumer Level – increasingly consumers want ethical products and will exclude companies that do not have regard for the environment and social impact of their businesses. In an increasingly competitive market, there is no choice but to listen to the consumer.
Venture Capital 2021 – Where are we?
Venture Capital activity in 2020 remained robust despite COVID. We saw a slight pause in Q2 as VCs sought to identify the impact on their existing portfolio prior to deploying more capital. We also saw more capital in late-stage Venture given the risk appetite of investors during those uncertain times. Fundraising and deal activity did quickly pick up. As was widely reported, overall deal volume was down but deal value held, demonstrating a concentration of capital with brand names.
In the second half of 2020, we saw VC capitalise on opportunities presented by COVID – there was a surge in the healthcare (particularly pharma) and technology (particularly supply chain technology, medtech and social tech) sectors and this continued into 2021.
In 2021, deal activity has picked up and we are seeing some interesting trends. There is an ongoing focus on sub strategies/niches such as Supply Chain Technology where, for example, artificial intelligence and robotics are being deployed - be it in driverless lorries or enhanced/live tracking of shipments. We also continue to see strong investment in the biotech and pharma sectors as health remains at the forefront of our minds. A further development is the ongoing diversification of typical private equity (buyout) and debt managers. We are seeing such managers enter the Venture Capital space (building or buying expert teams) as they hunt for yield.
So, 2020 was a challenging year, but a year where Venture Capital activity remained robust. The acceleration of investment in healthcare and technology continues into 2021 and its important and encouraging to note an increasing sense of responsibility within the industry and to consider that a lot of this investment will likely benefit the planet and each of us in the years ahead.