WHY SUSTAINABLE (ESG) IS COMPATIBLE WITH VENTURE CAPITAL INVESTING
According to an August 2021 article published in the Stanford Social Innovation Review, more than $100 million in assets under management (AUM) operate using environment, social, and governance principles (ESG). However, venture capital only is one area that has been left behind. The same article reports that of the world’s top 50 venture capital funds, only five have implemented ESG principles into their platform, and only a few dozen more have publicly committed to supporting ESG. Venture capital and ESG platforms are compatible. ESG investing refers to criteria that address sustainable goals, and it is often described as impact investing, socially conscious investing, sustainable investing, and socially responsible investing. Data support that venture capital funds have lagged behind the entire market in the last few years. A Forum for Sustainable and Responsible Investment Biennial Trends Report, published in a Goby April 2021 article, stated that US-based AUM that used sustainable investing strategies totaled $12 trillion in 2018 and grew to $17.1 trillion beginning in 2020. However, only an estimated 11 percent of the firms in the US invest based on ESG. Further, the largest venture capital funds in the world have not included human rights as a consideration in their investment process. Diversity and inclusion are the only considerations most venture capital funds have adopted mostly across the board. Alternatively, some experts predict an increase in ESG integration in venture capital funding to happen in the next few years. In June 2020, a Morningstar Passive Sustainable Funds report stated there were 534 sustainable funds globally totaling $250 billion. The environment is ripe for venture capital funding to incorporate ESG principles into its investing process. In the last few years, natural disasters combined with climate change have been one of the reasons socially responsible investing has become a priority in the last few years. Additionally, racial and gender issues have become important considerations in venture capital funding. For venture capital funding, ESG has a few benefits. For example, these funds usually have a long lock-in term, which meets the needs of projects that require a long time secure capital. Another reason venture capital funding goes well with ESG platforms is that fund investors can sometimes contribute to the start-up or the product being created in terms of technical knowledge, management skills, and industry connections. This works well for start-ups in providing them the tools to innovate and commercialize the product using ESG. Incorporating ESG into a venture capital fund also provides the platform with some protections. Of all the different investment types, venture capital is probably the riskiest. These risks relate to regulatory uncertainty, the performance of new technologies, and drafting fair terms for customers, among other issues. ESG frameworks mitigate risk and address societal impacts because they provide risk management tools to address the myriad of issues the project/fund faces. The ESG platform works in terms of generating data on venture capital funds. While consumers can find ESG information on public companies, it is not found in the general venture capital market. This is important in the decision-making process because the data often generates information regarding environmental efforts and outcomes, and it gives information on industry-wide practices. This information could help fund managers create risk-mitigating filters that lead to positive financial outcomes. Finally, integrating ESG would create a diverse venture capital sector. The Goby article attributed a Harvard Business Review report that stated only 2.3 percent of women comprise the venture capital market in 2020. An ESG platform would support these goals.