How to deal with an (ESG) incident — towards a proper process
Unforeseen incidents, related to ESG broadly defined, in the portfolio of venture capital firms are common; appropriate responses to such incidences, which can range from fraud or sexual harassment to the launch of a controversial product or labour issues within the supply chain, are not always clear. With the help of our community, we’ve put together this process-focused document to enable the establishment of ‘better practice’ across the ecosystem:
Download a pdf of the document here.
Process steps:
1. Due diligence: culture check
When conducting due diligence on a company, to a certain extent incidents can be prevented and the right processes can be installed ex-ante.
• Ask questions around whistleblowing (for employees). How is the reporting of an incident encouraged and enabled in the firm? How are employees supported?
• Some (later stage) funds also perform standard security checks of the company founders (e.g. using consultancies, such as Secure Value, Kroll or Control Risks).
2. Right of information: creating transparency
Term sheet clauses (and side letters to legal documents, such as the Shareholder Agreement) can cement your information rights as investors. While board members usually have no problem securing such rights, investors who don’t take a board seat may still be able to negotiate the right to be informed.
3. Portfolio support work: preventing issues
There are a variety of steps that can be taken post-investment when working with portfolio companies to prevent incidents from occurring; a Code of Conduct (as discussed during e.g. the onboarding of new team members) and good and bad leaver clauses (including financial motivations) can be helpful tools to establish the right employee and leadership culture.
4. Incident identification: what is ‘an incident’?
The occurrence of a potential incident will likely be brought up by the responsible investor / board member. Some people consider the easiest check to establish the occurrence of an incident ‘the front page test’. Does the news about this new product / funder / customer / supply chain / case of sexual harassment have the potential to land on the front page of a yellow press newspaper? Or in other words, an incident is “any event or behavior that may significantly impact the VC firm’s reputation, integrity, or operations or its portfolio companies.”
5. Reporting: transparent communication
Once the incident is confirmed, it is important to have a clear understanding of responsibilities and who to inform. Do all board members know? If not, do they need to be informed? Which (key) LP’s need to be informed? Are there regulators to inform or the police? A list of key potential parties could be drawn up by the board (ideally ex-ante), and responsibilities should be distributed across the (VC) team and every individual board to alleviate the burden away from a single person.
6. Investigation: independent committee in charge
While the board (and co-investors) have to own the investigation, an independent committee is likely to be needed to manage the necessary analysis. This committee with external non-executive members — where needed — can hire in additional external support in the form of lawyers, accountants or forensic investigators. During the investigation, the committee should be the only entity to receive updates from the independent investigation. The people being investigated — where possible — should be placed on paid leave during the investigation.
7. Resolution: recommended mitigation plan
The independent committee recommends a resolution plan to the company board. How are victims supported? What are the goals of the restitution? What is the timeline? Next steps need to be clearly defined.
Likely outcomes could include:
• Plan to transition out the company members implicated
• Report to regulators and authorities if needed
• Put in place a corrective action plan (that may include new policy or training)
• Publish internal (and external) communication to provide further transparency
• File an incident report
• Include periodic updates on progress to the board
If the board majority rejects the recommendations, one possibility (depending on the severity of the incident) is to consider resigning from the board (if a member to begin with) and/or to stop participating in further funding rounds.
Note: we do not recommend developing a standard prescriptive protocol; all incidents are unique and require a specific case-by-case approach. Responsibility for this work needs to be clearly assigned and can lie with respective board members or Heads of ESG / Legal.
For more information about VentureESG and how we’re working to support Venture Capital funds with implementing ESG across their fund operations and end-to-end investment process, visit our website or drop us an email at hello@ventureesg.com.
