Sustainability/Analysis/

What does the ESG reckoning mean for VC?

It's a lot easier to care about ESG in a bull market. What does the current reckoning mean for venture capital?

By Freya Pratty

“If I had to choose between switching to renewable energy or keeping staff on, I’d definitely put aside that energy transition,” Micol Chiesa, formerly head of impact at Five Seasons Ventures told me this week. “And that’s a fair choice,” she added. 

Her comments sum up the current reckoning that ESG is facing perfectly. The acronym arrived in the mid-2000s to describe how investing could bear more than just profit in mind — you could invest and do good. 

The mantra worked well for the long bull market that followed the global financial crisis, but rising inflation and geopolitical concerns are revealing just how fragile this philosophy is when the going gets tough. 

But that fragility might matter less in VC, one of the last asset classes to embrace ESG. Mainstream European VCs only started getting serious about ESG around 2019, and many have already pioneered frameworks they think work better. VCs often tell me the term has long been too baggy and catch-all to be useful. 

Chiesa says one industry peer said that although there may be problems with the framework, saying ESG is dead is like saying human rights are dead.

“But as a framework, it might be dead.” 

Startups need focused KPIs on things like sustainability and diversity, Chiesa says. Early-stage companies often won’t have experts in-house, so VCs can help by generating KPIs, but they need to be a lot more directional and specific than the baggy “ESG” acronym allows. 

“Startups need more direction, so VCs are developing more personalised plans,” she says — formerly at Five Seasons Ventures, they’ve developed their own framework. “ESG”, Chiesa says, is just a tick-box accounting exercise for startups; whereas individualised KPIs can make actual change.

“As currently practiced, most ESG investing delivers little to no social or environmental impact”

Lena Thiede, partner at Planet A Ventures agrees. “As currently practiced, most ESG investing delivers little to no social or environmental impact,” she says. She advocates using the Upright Platform, which measures very specific metrics — things like the number of jobs created, the emissions or waste produced. 

The VC firm 2150 has developed yet another metric. It establishes a ratio for every tonne of CO2 a portfolio company emits, compared to how many it saves. Companies could be described as “3x”, for example, if they save three times more carbon than they emit. 

VCs are turning towards more specific metrics — but if they all turn to different ones, we lose the ability to compare across portfolios. That’s one thing the ESG acronym brought to the industry — benchmarks help to hold the industry to account, and spotlight people doing genuinely good work.

A lot of VCs are now using the UN’s Sustainable Development Goals (SDG) framework. There are 17 of them, so by nature they’re more specific — things like “clean water and sanitation” or “gender equality” — though I’ve also heard the argument that there’s so many of them, and any startup could be fitted into one of the goals. 

The European Union’s new green taxonomy is expected to go some way in preventing the greenwashing that ESG’s accused of allowing. It’s going through each industry and specifying which are sustainable activities and which aren’t — meaning investors can no longer self-declare a startup’s activity green. 

The tech downturn and ESG-focused startups

So beyond the term itself, what do current events — a likely recession and a downturn in tech stocks — mean for ESG-focused startups?

Chiesa tells me that she’s seeing portfolio companies with a sustainability focus find it easier to get debt financing than those without. “We’re talking a couple of percent, so instead of being 5 to 6%, for them it might be 3 to 4%,” she says. 

There’s also a lot of dry powder left in the market for climate tech — the number of specialist funds that popped up in the last year, when conditions were better, is high, and they’ll still have specialised capital left to deploy.

Until electric scooter startup Voi recently announced it was letting staff go I was yet to hear of a climate tech startup laying people off in Europe. That’s partly because most of them are smaller than the Klarnas or Getirs of the world, and will have lower staff costs. It’s also true that climate techs can rely on talent’s desire to work in the sector, rather than just the lure of high pay cheques. 

Perhaps, too, although the situation in Ukraine will lead, in the short term, to less environmental choices, the longer-term effect will be to highlight the necessity of sustainable choices.

“The war in Ukraine has turned Europe’s energy policies upside down and that will create an acceleration in renewable energies”

That’s the view of Bo Ilsoe, partner at NGP Capital. “The war in Ukraine has turned Europe’s energy policies upside down and that will create an acceleration in renewable energies and solutions that can lower carbon emissions and transform energy use,” he says. 

“It’s clear that startups in those areas offer investors a robust, long-term option and hope for the future.”

Other VCs are looking to the cleantech bubble for reference — where investment into green technologies was rising up until the recession hit.  

“Today in climate tech, the sense of urgency and the alignment between governments, consumers and corporates is much stronger than in 2006 during the first cleantech wave,” says Fabrice Bienfait from ETF Partners, which launched in 2006.  

“However, as capital gets more expensive as it did during the financial crisis of 2008, businesses with asset-heavy economic models are likely to be more exposed. This is undoubtedly one thing VCs in the cleantech era learned the hard way.”

Freya Pratty is a reporter at Sifted. She tweets from @FPratty and writes our sustainability-focused newsletter — where this analysis first appeared — you can sign up here.

A quote from Chiesa about human rights was incorrectly attributed as her opinion and has been changed to reflect that she was quoting the opinion of others.

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