The central importance of sustainability for our society and economy has not passed by in the private sector. On the contrary – the private sector has a key role to play in pushing the UN’s climate and sustainability goals. Many companies have already taken a pioneering role in terms of sustainability and are integrating sustainability goals into their strategic business decisions. The investor world even goes a step further and has developed a systematic approach to promoting sustainability. The so-called ESG factors (Environmental, Social & Governance) serve as the basis with which investors analyze and evaluate companies with regard to their sustainability.
For us at FLEX Capital, too, the issue of sustainability is very important, and we deal with it at all times in the investment process. In this article, I would like to share our assessment of the general relevance of ESG from an investor’s perspective and what the consideration of ESG criteria in the investment process means for entrepreneurs.
What is ESG?
ESG is often associated with “sustainable investing”. The ESG factors are the three overarching criteria that can be used to determine the sustainability of an investment. Investors are increasingly considering the criteria in their investment decisions. Each investor can decide for himself what these criteria mean in detail and how they are applied. In general, however, the criteria include the following factors:
E as in Environmental
This criterion includes all the effects that a company has on the environment. This includes a company’s carbon footprint, its handling of water and waste, and the ecological impact of the products on offer. In addition, this criterion examines possible activities or efforts of the company to reduce the carbon footprint, water consumption or waste.
S as in Social
The social criteria include how the company treats employees, customers, suppliers and other people from the company’s social environment. This also includes the efforts and activities of the company with regard to occupational safety and health of employees, human rights and general working conditions.
G as in Governance
This criterion checks the quality and effectiveness of corporate management and ethical behavior of the company. This includes, for example, that the rights, responsibilities and expectations between different stakeholders in the management of companies are clearly defined. This criterion also includes factors such as equal opportunities, diversity, transparency and dealing with corruption.
Our approach to responsible investing and key ESG issues are highlighted in our FLEX Responsibility Framework. It covers essential ESG topics and is based on a comprehensive benchmarking of best practices and industry standards. We always endeavor to adapt our framework to regulatory changes and emerging ESG issues and to meet the expectations of our investors. All of our portfolio companies, as well as FLEX itself, are assessed using this framework in every phase of the investment cycle.
- Environmental & resource efficiency: Responsible and efficient use of resources, including water and energy, as well as the use of sustainable energy sources.
- Climate change: Pronounced environmental awareness and obligation to promote climate neutrality, especially with regard to travel and fleet management.
- Waste management: reducing the amount of waste generated and the environmental pollution caused by waste disposal through recycling and reusing.
- Diversity & equal opportunities: Active promotion of diversity and guarantee of equal opportunities regardless of gender, ethnicity, disability or religion.
- Dealing with stakeholders & communities: Respect for the local social conditions in which we and our portfolio companies operate, as well as treating all of our stakeholders with respect.
- Data protection & security: Appropriate data protection measures with regard to the handling of all private data and compliance with local guidelines.
- Labor rights & conditions: Compliance with labor rights and guarantee of working conditions that go beyond basic health and safety standards.
- Business ethics & management: Compliance with standards relating to good corporate governance and ethical behavior, especially with regard to corruption, harassment and other misconduct.
- Regulatory & compliance: Observance of all laws and regulations in accordance with the locally applicable provisions.
- Transparency & accountability: Transparency about our ESG commitments and the progress of their implementation, including regular reporting on all ESG-related issues.
Why is ESG relevant for investors and companies?
The high relevance of ESG for investors and entrepreneurs is made up of various factors. An important aspect is the growing awareness of the population for sustainability and environmental protection. Supported by movements such as “Fridays for Future” and “Black Lives Matter”, this awareness is putting increased pressure on investors and companies to take ESG factors more into account in their decisions.
In addition, there are more and more studies that show a positive effect of ESG activities on the performance of companies. The reasons for better performance are easy to understand. Companies that act sustainably and convey a positive image with regard to ESG can build a competitive advantage and thus accelerate their growth. In addition, the economical use of resources such as energy and water can reduce costs for the company.
Even if many companies are confronted with extreme circumstances due to Covid-19 and therefore understandably place present decisions above future decisions, the topic of ESG has by no means lost its importance. Quite the opposite – several studies show that taking ESG criteria into account can increase the resilience of companies in times of crisis (EY, 2020). Entrepreneurs who incorporate ESG factors into their corporate strategy often have a better understanding of how their business activities affect the environment and stakeholders. In addition, you usually have a better overview of ESG-related economic risks, which, according to the annual risk report of the World Economic Forum 2020, make up the top 5 most likely and most serious risks for the global economy. This knowledge advantage serves as critical input in order to develop a sustainable and resilient business strategy in the long term.
What do investors’ ESG guidelines mean for entrepreneurs?
Every investor handles the exact interpretation of the ESG criteria and their implementation differently. Our approach at FLEX Capital includes clear ESG guidelines that are integrated into the entire investment process. This has the following implications for our potential and active portfolio companies:
Check against exclusion list
We check every potential investment against our exclusion list. This includes industries, business models and activities in which we do not invest due to our moral and ethical values.
ESG due diligence
As part of an ESG due diligence, we evaluate potential investments using our “Responsibility Framework”. This includes what we believe to be the most important ESG topics and is based on extensive benchmarking of best practice examples and industry standards. Entrepreneurs can expect a close scrutiny of their ESG activities. In addition, all potential portfolio companies must meet the minimum ESG standards we have defined. Identified ESG risks or a poor ESG rating can lead to a reduction in the purchase price or a negative investment decision.
ESG goals & reporting
During the investment period, we support our portfolio companies with ESG management in order to ensure the implementation of our ESG guidelines. To do this, we work with the portfolio company to define ESG goals and a corresponding plan for implementation. The progress of the implementation is then regularly evaluated.
Even if the consideration of ESG criteria in the investment process means a greater effort for the entrepreneurs of active and potential portfolio companies at first glance, they ultimately benefit from the positive performance effects. Finding a way around the topic of ESG seems difficult anyway. According to a study by PWC (2019), over 90% of the private equity funds surveyed already have formal ESG guidelines or are in the process of developing them. It can be assumed that this rate will continue to rise and that many funds will further professionalize and develop their ESG guidelines in the coming years.