By Veronique Hördemann, CFO Future Energy Ventures

ESG has been under the microscope in the past 12 months with pressure from some Republican politicians in the US who have called for investment managers to pull their clients’ money from ESG focused investments.

Simplistically, their argument is that ESG prevents investors being able to access assets like fossil fuels and by doing so they will have ‘missed-out’ on soaring fossil fuel company valuations which have been driven by rising energy prices. Those on the ‘anti-ESG’ side argue that continuing to follow ESG doctrine in today’s market fails investors and is therefore a failure of fiduciary duty by investment managers.

This of course overlooks one rather fundamental challenge. The IPCC in its recent AR6 report stated that the G7 economies needed to hit net zero by 2040, not 2050, if we are to avoid catastrophic climate change which equals economic as well as planetary Armageddon.

At COP26 countries pledged to ‘scale-down’ the use of oil and fossil fuels. The latest scientific evaluation from the IPCC sets the scene for a future COP (not too far in the future) making the pledge to ‘scale-out’ fossil fuels and accelerate the already significant investment into an electrified and decarbonised future.

[Learn more about: Accelerating clean energy start-ups]

So the fiduciary duty of investment managers when seen through that lens would suggest a long-term imperative to ensure that the funds they manage are not placed into assets that will become stranded or obsolete. In other words, investing using ESG metrics and favouring renewable and Climate Tech type investments makes economic and investment sense into the long-term.

This approach is one that we at Future Energy Ventures follow and we’re not alone. Despite recent controversy, the ESG investment market is estimated to be worth $53 trillion globally by 2025 and data, reported by Bloomberg, from the European Fund and Asset Management Association (EFAMA) has shown that the EU’s highest environmental, social and governance classification, known as Article 9, drew-in €26 billion ($28 billion) in 2022. That coincided with bond funds seeing client outflows that were greater than since the global financial crisis in 2008, while equity funds also suffered, losing €72 billion over the same period. 

Regardless of the critique, ESG-focused investing is drawing in significant funds and is set to represent around a third of all funds under management by 2025. Whether you believe in ESG or subscribe to the ‘woke capitalism’ viewpoint, it simply can’t be ignored and any company seeking funding needs to ensure that it is structuring its investment case accordingly.

Yet despite this, far too few companies, particularly at a scale-up stage, are thinking ahead to how they structure their investment case so that it appeals to a wide range of investors, particularly those that follow an ESG criteria.

Data from EFAMA shows that significant money is flowing into Article 9 funds yet in order to become a portfolio investment for one of these funds the company seeking investment also needs to meet Article 9 criteria otherwise they fail to meet the investment criteria.

This means that having a brilliant idea, business plan, IP and a team to deliver it is no longer enough for entrepreneurial start-ups looking to secure funding if they want to tap Article 9 investors. Instead, they also need to bake in ESG metrics into their business model and demonstrate positive social and environmental impact from the start if they are to secure the investment they need.

For many entrepreneurial start-ups this creates an additional knowledge barrier that they have to overcome in building their business. However, addressing that up front will reap dividends, not only in securing early-stage funding but also in enhancing their scale-up potential and by making their business potentially more valuable (and certainly more investable) and by facilitating ease of exit.

[Learn more about: The Future of ESG & Climate Impact]

That changes the parameters for both the investor and the investee. Investors need to accept that they have a role to play as coach and guide to help start-up entrepreneurs understand what they need to report and the impact they need to demonstrate as part of the value they add to the businesses they are investing in.

At FEV we have always seen our role as both a mentor and investor. Accessing funds from our LPs requires us to work with our portfolio companies to ensure that they are equipped to report success and impact in ways that sit beyond traditional P&L.

This becomes all the more important in a world where there is no single standard for what ESG means and how it is reported. This results in many entrepreneurial companies (and larger cap businesses as well) being utterly confused about what they should report and how they go about it. It is therefore incumbent on the investor to help drive value and deliver impact through wider ESG performance to meet the reality of a world that seeks impact as well as profit from business.

In this new world we are seeing a reformulation of the role of the investor. No longer there just to seek return but also to add value, support growth and act as a steward of capital and also of impact.

Companies seeking investment need to understand that change in investor outlook and make it as easy as they can for investors to vet, approve and want to make investment into their company. It means starting a business with a clear idea of how you will seek scale-up finance, what your exit plan might be and how you facilitate all those elements in your growth journey and that means baking ESG into the DNA of the business from day one.

A version of this article was originally published by TechCrunch

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