The Importance of ESG for Private Companies
Over recent years we have seen the emergence of the consideration of environmental, social, and governance (ESG) issues as an important trend in the public markets. Investors have realized that ESG issues can have a significant impact on company and portfolio performance, and public companies have been pushed by investors and other stakeholders to provide enhanced disclosure around how they identify and manage material ESG issues.
But what about private companies? Are they facing the same scrutiny from their investors, and if not, should they even bother committing the time and resources required to manage ESG issues? The reality is that ESG issues are just as material for private companies as they are for public companies, and that by identifying, monitoring, and managing these issues private companies can, like public companies, enhance overall risk management and improve long-term performance.
Some ESG Basics
There is often a lot of confusion as to what ESG is. A good place to start is to provide a definition and some examples of the kind of issues we are talking about when we refer to ESG.
The Benefits of Integrating ESG for Private Companies
When considering taking a more proactive approach to integrating ESG issues it is important to identify what the potential benefits are for your organization. Below are some of the more common and most significant benefits that can be realized from the integration of ESG issues for private companies.
- Enhanced risk management: There is a tendency to focus on risks that are more easily identified and managed, and especially risks where the financial impact can be easily understood and quantified. ESG risks can often be more difficult to identify, tend to be longer-term in nature, and the ultimate financial impact can be difficult to quantify. However, risk is risk and ESG risks can and do have significant financial impact on companies. While it can take more time and resources, going through the exercise of identifying the material ESG risks for a private company can significantly enhance overall risk management.
- ESG issues are longer-term in nature: The impact of ESG issues is often cumulative and the impact is felt over a longer timeframe. For example, a company that compromises on worker safety may save money in the short-term, but over the long-term will have reduced workforce productivity, lower employee morale, and increased fines and insurance premiums. As such, ESG issues are often important considerations when developing long term strategies and considering allocating capital to long-term projects.
- Quality of management: Being able to demonstrate that you are identifying and managing material ESG issues sends a strong signal to stakeholders (providers of capital, customers, governments/regulators, employees, communities, etc.) about the quality of management. If you are managing ESG issues well then you are likely to be managing all aspects of the business just as effectively.
- Accessing capital: Even through private companies do not face the scrutiny of the public capital markets, there is still the need to access capital whether it is debt (financial institutions, private investors) or new equity investors. Increasingly these providers of capital are incorporating ESG into due diligence processes 1 so being able to readily provide ESG information is a growing expectation for many providers of capital to private companies. This is especially true if a private company is considering an IPO. Identifying material ESG risks and developing internal monitoring and reporting pre-IPO will position the company well for what will be expected post-IPO and increasingly as part of the IPO process.
- Identifying opportunities: ESG is not just about risk, it is also an effective way to identify opportunities as ESG issues emerge and evolve. Many ESG issues influence or even drive market trends that in turn create opportunities for new products and services and by actively monitoring those ESG issues companies are better able to identify those opportunities earlier. This is also true for adapting current products and services to emerging trends. For example, reducing greenhouse gas (GHG) emissions and thereby lowering the carbon footprint of an existing product can be a differentiator and a competitive advantage over competing products. In addition to revenue opportunities there are also significant opportunities to reduce costs and improve efficiency. To use the previous example, not only does reducing GHG emissions make products more attractive, but it also reduces energy costs over the long-term with a direct impact on the bottom line.
Overall, working through the process of identifying what ESG issues are material for your organization, integrating these issues into long-term strategy and risk management, and developing internal monitoring and reporting will be time well spent in terms of better risk management and improved long-term performance.
Where to Start
A good first step is to undertake an ESG materiality assessment. A materiality assessment is exactly what it sounds like, an assessment that identifies the financially material ESG issues for your organization. It is important that the board and senior management be involved in the process, and often talking to key stakeholders such as customers, suppliers, lenders, and investors will provide valuable additional input into the materiality assessment process. It is also important that ESG issues be considered in the context of operational and financial considerations as well as the long-term strategic plan for the company.
In terms of monitoring and reporting, the best place to start is the Sustainability Accounting Standards Board (SASB) Standards. SASB has developed standardized guidance for sustainability reporting, similar in many ways to the standards that are used for financial reporting. The SASB Standards identify the subset of ESG issues most relevant to financial performance in each of 77 industries, and they are designed to help companies disclose financially- material sustainability information to investors. Rather than adopting the standards wholesale, SASB recommends that each user of the standards determine what issues are material for their organization. Many companies will select recommended metrics from multiple sectors to reflect their unique business model and material ESG issues.
Although SASB provide detailed guidance on implementation of their standards, the guidance is not as prescriptive as financial accounting standards and provides a lot of discretion on what to disclose and how to disclose it.
For private companies, the focus will be on internal monitoring and developing reporting for senior management and the board. By using SASB as the basis for your ESG reporting it will be focused on material issues only, require less internal time and resources, and will allow the data to be easily adapted to produce the internal and external reporting that is needed. If you do not want to commit significant time and resources initially on an ESG initiative, SASB allows you to start small and build out reporting as you develop internal capacity and expertise.
The Final Word
Risk is risk. It seems an obvious statement, but all too often companies are ignoring material ESG risks because they are viewed as “non-financial”. What the public markets tell us is that ESG risks can have a significant impact on long- term performance, and you ignore them at your peril. Private companies can learn from the lessons we see in the public markets and identify, monitor, and manage those material ESG issues to ensure that a risk does not turn into a crisis.
About Koru ESG
Koru ESG is an independent environmental, social and governance (ESG) consulting firm providing advice and support to investors, issuers, and other consulting firms on all aspects of ESG. Headquartered in Vancouver, Koru ESG was founded by Jason Milne, an experienced investment industry professional who has specialized in ESG, corporate governance, and responsible investment in Canada for the last 20 years.