ESG in Private Equity: How to Build a Strong Sustainability Plan

September 23, 2022

ESG in Private Equity: How to Build a Strong Sustainability Plan

Within a very short time, environmental, social, and governance (ESG) issues have risen from the sidelines to the front line of corporate or business agendas. However, a large percentage of companies, including private equity (PE) firms, are still grappling with how to execute the ESG imperative. Private equity (PE) companies find it challenging to balance between generating returns for investors and achieving the broader ESG or sustainability goals demanded by investment and other stakeholders. In this post, we take a closer look at ESG in private equity firms to demonstrate how to craft a strong sustainability plan. 

Issues Facing Private Equity Firms 

  • Potential with individual and unique mandates that private equity firms must adhere to in line with the requirements of fund investees. 
  • Portfolio companies that have very high requirements, such as zero emissions, can easily suppress the supply chain.  This challenge results from the fact that most stakeholders opt to follow what portfolio companies are demanding. 
  • There is a rapidly declining pool of funds if the private equity firms fail to meet the pre-set ESG expectations. 
  • Equity firms are, at times, disadvantaged when they are bidding for specific targets that feature ESG risks and opportunities when the competing companies have a bigger ESG-related capability or leverage. 

We must also indicate that the above issues are also evolving with time, making the management of ESG in private equity firms even more challenging. A recent survey by Global PE Responsible Investment established that 37% of investors are willing to turn down investment opportunities if they have ESG concerns or issues. Therefore, you have to take a closer look at sustainability to understand its impact and dynamics, and craft an excellent ESG plan for your private equity. 

Preparing for Effecting Disclosure of ESG in Private Equity Firms 

Now that you know the issues facing private equity firms, it is time to take action, but where do you start? Which investment practices should you select for better performance and support from partners and other stakeholders? Here are the preliminary measures for ESG in private equity firms. 

Gather the Necessary ESG Information

Your fund should start by gathering and diagnosing the entire portfolio. Remember to be as accurate as possible because the information you gather, whether it is on carbon footprint or governance strategies, should be as accurate as possible to avoid the danger of greenwashing or straying outside investors’ preferences. Here are some useful steps to consider: 

  • Start by examining the portfolio companies that are about to exit. This is crucial in determining what the companies should focus on to meet emerging market expectations. 
  • Then, take a closer look at the companies with the most notable sustainability concerns. Your company might want to focus on an issue such as forced labour practices in the clothing industries or medical waste in the healthcare industry. Other areas preferred by capital investment firms include conservation of public biodiversity resources at the local and international levels. 
  • Look at different industries in your portfolio and appreciate that most businesses still have environmental, social, and governance implications. A tech company might not directly have environmental-related issues, but its suppliers might be contributing to water/ land pollution. 
  • Lastly, you have to look at the newly acquired companies in your portfolio. Think of how businesses can be helped to shine in relation to sustainability matters. This should be considered in line with the emerging compliance requirements in your industry. 

ESG in Private Equity Firms: The Main Steps to Follow

To improve ESG in private equity firms, here are the four main steps that managers should follow: 

  1. Start by Assessing the Current Position

You cannot move ahead unless you establish where you are now. Therefore, start by evaluating the areas where your private equity firm is at the moment. For example, have you noticed some ESG initiatives are helping your business to have an edge in attracting new talents? Go ahead and check other approaches, such as privacy protection, that should also be considered in your portfolio.

  1. Define the End Goals 

After appreciating who your portfolio companies are, the next step is defining the objectives. At this point, it is prudent to factor in what the industry investors or funds providers prefer or care about most. Take the example of the manufacturing and healthcare industries. These two sectors have always prioritised the safety of staff. This understanding will help you to develop more ESG-specific capabilities for tracking progress. 

  1. Identify a Plan or Strategy for Delivering Your ESG Goals 

The success of ESG in private equity is only possible if you have a clear plan. Therefore, what methodology should be employed for carrying out due diligence and data collection? It is important to factor in relevant data by employing diagnostic tools that help you pinpoint the best options with greater potential. Some good action plans include augmenting training and changing workplace practices. 

  1. Review the Strategy and Implement Changes for Improvement 

Building a business for sustainability investment requires you to demonstrate good knowledge of the subject. For example, you should demonstrate that changes in a manufacturing portfolio company can help to bring substantial improvements of ESG ratings. Therefore, every strategy for ESG in private equity firms should be reviewed regularly and changes made, where necessary, to ensure it is moving towards the predefined goals. 

Crucial Tools for ESG in Private Equity Companies 

To implement the above four steps, it is prudent to appreciate that the bulk of the work involves data and its analysis. Therefore, you should have the following: 

  • The right ESG Sustainability Framework

To make plans for ESG in private equity firms work, you should identify and apply an appropriate framework. This is similar to a guide that helps to align the process of data gathering. Some good examples include the Task Force on Climate-related Financial Disclosures (TCFD) and Sustainability Accounting and Standards Board (SASB) models.

  • ESG Management Software

The process of data gathering and analysis can be pretty challenging, especially when done manually. The best alternative is to select appropriate sustainability management software that can help with data gathering and analysis. The app also helps to stick to the main principles of ESG reporting, such as accuracy and materiality. 

This post has demonstrated that ESG in private equity is faced with a myriad of issues, and crafting an appropriate strategy can be pretty challenging. We have also outlined the best steps and tools that you should use to make your equity firm stand out. Remember that in addition to the tools we have listed above, you should also consider working with an agency of experts. Contact us at Diginex.com for the best ESG sustainability reporting apps and expert assistance on ESG matters. 

Recommended