The Rise Of ESG: Potential For Tech Startups

Concerns about the environment, society, and governance (ESG) permeate every business. Companies – both big and small – are impacted by the strengths or weaknesses of their ESG strategies, and with growing significance, investors too are taking note of the ethical considerations of the ventures they choose to invest in.

For starters, investors look for start-ups whose values align with theirs but it goes beyond just a shared value system. As the field grows and evolves, investors investigate the role of ESG not as an end product but as a core ingredient of traditional financial analysis.

In a survey by insurance and pensions provider Aviva last year, 55 per cent of investors said that the pandemic had made ESG factors more important to their investment decisions while Assets under management (AUM) for ESG-themed funds jumped from $275 million in FY20 to $650 million in FY21, a two-fold increase. "The Next Big Leap" toward ESG maturity in the tech sector stated that over time ESG could emerge as a key differentiator in large tech transactions.

That is why it is important for start-ups to understand the full scope of ESG and explore the opportunities that investors already know them to include.

So, what exactly is ESG?

ESG conjures up images of global warming and the depletion of natural resources for many. But the term encompasses a wide range of topics, these being just a few of them. Operational issues like worker rights, product safety, data security as well as cultural ones like board diversity, executive pay, and corporate ethics are all addressed under the broad spectrum that ESG covers.

What ESG means for start-ups

ESG practises have become more important to the majority of start-up founders since the Covid-19 pandemic struck. And today, it is unquestionably more of a topic than it was even a year ago. Since ESG is growing in significance amongst both institutional and retail investors, poor ESG practises can have a negative impact on a start-up’s prospects. Specifically, from the perspectives of investors, ESG’s main focus areas for start-ups are:

The Environment Aspect

Investors are adopting the ESG framework to ensure a sustainable future in the face of global resource depletion and climate change. Therefore, the enhanced use of sustainable energy and raw materials, pollution control, and climate change mitigation are the primary goals of ESG investing.

The Social Consideration

Social responsibilities that include things like how they treat customers, suppliers, employees, and other members of their surrounding environment and community. Working conditions, diversity, and health policies are all examined under the social head. What is also assessed is the company’s ability to stand for social good as and when the time arises. The Black Lives Matter movement in the US has become an iconic example of corporate social responsibility in the recent era.

The Governance Problem

ESG investing aims to identify and invest in companies that are well-governed and use accurate and transparent accounting practises. Here, the audit committee structure, board composition, executive compensation, political contributions, and bribery and corruption are examined.

In the tech sector – Making an ESG PoA

As the sense of urgency increases among start-up founders, the tech sector is also gearing up to make greater changes. But start-up entrepreneurs typically lack the time or resources to devote to ESG at early business development stage, that’s why it is necessary to devise a plan of action that makes sense for businesses that are low both on financial and human resources.

While ESG standards have yet to be institutionally established, tech companies can take three measures to improve ESG within their own organisations.

Implement an ESG strategy

To develop an ESG strategy, IT businesses must first define expectations and strive for transparency. This begins with the development of ESG goals, their public expression, and the establishment of methods to assess and track ESG metrics.

Find areas where you can have an influence

When it comes to improving ESG standards, tech companies should consider areas where small adjustments can have a significant impact. A start-up could consider undertaking a project to make its computing tasks more efficient in order to reduce power usage and greenhouse gas emissions as part of its strategic vision. Moving to the cloud or adopting a serverless architecture, for example, can minimise energy consumption.

Other ESG measures, such as focusing on responsible supply chain management, developing corporate wellness programmes, and improving corporate governance, also benefit the organisation while also reducing risk. Tech businesses can discover possible compliance concerns in their supply chains early on by adopting responsible sourcing policies with their direct suppliers and sub-vendors. They can also plan for future ESG risks, such as political unrest or natural disasters, that could interrupt their supply chain and jeopardise their financial health.

Assess and report

Though ESG reporting for businesses is currently entirely voluntary, standards and obligations are likely to be established in the next years. Companies that start developing a measuring and reporting structure today will be better prepared to negotiate with future laws. And most of all, ESG reporting that is comprehensive can also assist the company by attracting investors.

Though ESG strategies may differ depending on the firm, its operations, financial resources, and overall strategic goals, it's apparent that tech start-ups still on the fence can no longer afford to be. ESG-focused IT companies will be able to effectively manage risk, investor and shareholder expectations, and future reporting requirements.

(The given article includes inputs from Andesh Bhatti, Founder, Collectcent, Angel Investor)