The ESG to SDG Continuum — Integrating ESG and Impact Across VC Processes
A Best Practice Approach From Pitango Venture Capital
This post has been authored by Cecile Blilious, Head of Impact and Sustainability at Pitango, Israel’s biggest VC fund platform. Founded in 1993, Pitango now has $3bn AUM and 90 active portfolio companies, invested through 3 parallel funds. Cecile is also a Steering Committee member at VentureESG. It is the fourth piece in a series of case studies from the VentureESG community.
In 2020, after careful consideration, we at Pitango decided to incorporate ESG and impact factors into our investment strategy for all of our funds. Our approach, branded the ‘ESG to SDG continuum’, is based on a combination of ESG guidelines and the UN Sustainable Development Goals, and therefore goes beyond traditional risk/return considerations of ESG to focus on impact and sustainability.
ESG and impact are not the same, but we believe that a holistic approach to both, alongside all other investment considerations, is the best way to achieve superior results on all fronts.
Why we take this approach:
The VC industry is not a huge part of the capital markets, but has a tremendous role in developing technological innovation for humanity. Impact-tech investing, whilst remaining a small part of the VC industry, is growing rapidly but will not be able to tackle all of humanity’s needs without the help of mainstream investors. Through its research, development, and innovative business models, the high-tech industry is increasingly disruptive to the economy and, as a direct result, society and our environment at large. However, tech innovation is still not sufficiently utilized to create a positive impact, as most of the capital deployed into startups comes from generalist VCs that have, thus far, not paid much attention to ESG or impact.
From this understanding, we concluded that it’s our role as a generalist VC to support innovations that help our society transition into a low-carbon economy and create a more sustainable future. We also wanted to include our existing portfolio companies, which have developed their businesses over the past few years and gained significant market traction, in the effort to improve our society and environment by integrating high ESG standards and potentially generating intentional impact retroactively. We wanted to merge the world of mainstream generalist tech investments with the world of ESG and impact in a way that produces returns to people and planet, in addition to profit.
Research shows that by introducing ESG practices to start-up companies, we can create financial value for them and for our investors, alongside contributing to a more prosperous society and healthier environment.
Similarly, we believe that impact-focused companies will become the leading forces of tomorrow, creating solutions for global social and environmental challenges, alongside generating superior financial returns. Hence we took it upon ourselves, as a leading venture capital firm, to help start-ups navigate the sometimes complicated waters of impact and sustainability.
Managing their ESG risks and thinking through impact opportunities can provide start-ups with what we call a purpose premium, resulting in:
- A strong brand and market presence that enhances customer loyalty and attracts new customer’s segments;
- Attraction and retention of top talent: Gen Y & Z prefer working for purpose-driven companies, with a particular emphasis on diversity and inclusion, in itself leading to better business outcomes;
- Access to impact capital typically reserved for mission-driven companies, as impact VCs are attracting increasing amounts of money;
- Compliance with regulation (e.g. SFDR in Europe).
The ESG to SDG continuum: our concrete process
All start-ups should be adhering to the highest ESG standards (regardless of their sector) and while there is no singular accepted standard, various frameworks can help define the material issues for a particular fund or company.
On the ESG front, at Pitango, we decided to focus on diversity and inclusion and the reduction of carbon emissions (Scope 1, 2, and 3), alongside robust privacy and governance practices that are at the core of software companies. We also believe that all companies should integrate ESG performance management. We mentor our companies in setting clear ESG-related targets and help to improve their performance over time.
At the same time, we’ve identified that most companies in our portfolio have the potential to create an impact through their products and services, correlated to the UN Sustainable Development Goals (SDGs), even though Pitango is not an impact fund. We focus on helping them identify and integrate relevant SDGs as part of their product offering and business models. This impact layer comes on top of the baseline ESG work, and only when relevant to prevent any kind of “impact washing”.
As a generalist venture fund, we recognize that not all of our companies will be focused on generating SDG-aligned positive impact outcomes for our society or our planet, so we place the companies on the ESG-SDG continuum and decide the best course of action based on this assessment. Our exclusion criteria is to avoid harm, based on the ABC framework created by the IMP.
We implement our approach in two ways, depending on whether an investment is new or an existing portfolio holding:
- New investments — ESG integration in the investment process
Before we invest, we ask companies to complete an ESG DDQ adjusted to their size, stage, and specialism (software-only or production-based), as this determines which ESG indicators are material and can affect desired future outcomes. This questionnaire was developed internally, referencing frameworks such as SASB, GRI, BCorp and others as guidelines, but with the necessary adjustments for startups.
Growth companies, for instance, are asked about their existing headcount and management team and their product development relating to privacy, carbon footprint, and governance. Early-stage companies receive a shorter version of our specific questionnaire that raises these issues as something to plan for and build within their culture and structure.
We take this questionnaire as a starting point for a conversation with the company founders to gauge their ESG readiness in building their businesses. Based on our findings, we score companies and prepare an ESG section in the investment memo presented to the Investment Committee. This includes an analysis of opportunities, risks, and recommendations. This is where red flags are brought to the attention of the Investment Committee, if there are any.
Our process in summary:
- Review the company business model and products/services
- Analyze potential ESG risks & opportunities
- Consider current and potential future impact strategies
- Develop a score based on our framework
- Draft an investment memo summarizing our findings
- Recommend actions and next steps for the investment
Our investment documents include an ESG clause in our standard term-sheet and a commitment to mentor the companies through an ESG process, focusing mostly on diversity, equity, and inclusion (DEI) and GHG emissions. With this approach, we both raise awareness and offer assistance in building the right ESG approach. As a result, engagement across (new) portfolio companies is very high.
Post-investment, we work with the company to implement the investment committee’s recommendations, develop and apply their ESG strategy, and set and track KPIs. For companies with an impact potential, we guide them through our “impact migration” process. With every portfolio company, we receive ongoing ESG updates, delivered both directly and through board presentations, in order to assist them and track their progress. For early-stage companies, most of the work is carried out by building the company culture and setting KPIs that are integrated into its growth strategy.
2. Growth startups & legacy portfolio companies — supporting with integration
For growth stage portfolio companies, as a first step, the company appoints a company-level Impact Taskforce composed of several key leaders, usually from HR, Legal, and Marketing. Taskforce members differ from company to company, but need to be a well-rounded group of leaders that will have both the knowledge as well as the influence on the integration of ESG/impact practices within the company. Pitango provides direct support and mentorship to the Taskforce.
The Task Force’s responsibilities are to:
- Align internal processes with ESG standards
- Identify ESG gaps and recommend necessary remedies
- Design an impact mission if there is one, identifying potential product impact
- Identify stakeholders and relevant SDG indicators
- Connect product outcomes with SDGs
- Integrate mission into core KPIs
- Track and improve on ESG performance, and when relevant, SDG integration
The following is a representation of a typical process:
We encourage our portfolio companies to onboard onto our chosen ESG management system, ESGgo, through which they can upload their data, calculate emissions and use a dashboard for internal management. We use the aggregated data from the companies to have a status overview. In terms of the focus of our data collection, we cover all areas of E, S and G:
Environment: we start with an initial analysis of operational carbon footprint using the ESGgo system, followed by recommended reduction measures and improvement tracking. As most of our companies are software-based, we focus on their operations and their ongoing use of resources. We encourage and assist companies to develop an environmental policy covering office, data storage, travel and other processes. Companies are encouraged to join a climate community (such as Leaders for Climate Action) to improve their performance.
Social: we assess companies’ employee-related activities, emphasizing DEI, and set KPIs for improvement. For example, we help them to increase their diversity in recruiting by accessing different talent pools, conduct externally-led inclusion activities performed with the teams, and encourage the conducting of a gender pay-gap analysis for growth companies. We support companies to develop internal policies that cover recruitment, training, profit-sharing, privacy, work conditions, and corporate social responsibility (volunteering etc.).
Governance: we review company policies and assist in providing examples, case studies, and training for implementation (such as a Code of Ethics, anti-harassment policies etc.). Privacy and safety measures are reviewed, updated, and implemented. Our appointed board members track progress and raise issues such as the gender pay-gap, board diversity, and compliance with regulations. We are in the process of integrating ESG status and progress updates in our quarterly board meetings, starting with DEI and, in the future, climate action. We are educating the boards in understanding and analyzing the risks and opportunities associated with the climate crisis.
The view forward: remaining flexible and providing support
Overall, our work with new and existing investees is focused on creating robust ESG strategies and including impact where relevant in companies’ operations and actions. None of the above is a one-size-fits-all approach, however. The good news is that we can automate some of the processes, but the flipside is that there is still a substantial amount of mentorship needed to lead the process, an expertise that does not exist in startups. This is why the venture capitalist’s role is still very necessary to scale implementation and progress.
We will track the KPIs set by our companies over time, whilst recognising that due to the agile nature of start-up companies that need to be flexible with their business models until they find the right product-market fit, KPIs may need to be adapted accordingly. When needed, we will assist companies to consider the impact of new business cases and stakeholders. Internal ESG targets should not differ greatly if a company changes its business approach or pivots from its original intent, but a renewed evaluation of stakeholders must be made and new KPIs may need to be set.
In the past few years, since we started implementing this strategy, we’ve seen the universe of GPs and LPs gradually integrate ESG and impact considerations in choosing and screening investments. This has been driven by rigorous regulations in Europe and the US and has pushed more and more generalist venture funds into adopting and implementing ESG strategies. This is good news, however there is still much to be accomplished to make sure this is implemented fully and with the right intention, in order to reduce the risk of green-washing and to ensure that startups are truly influenced in a positive way. Sharing best practices and making a collaborative and continuous effort to improve and learn from each other is critical to scale venture capital’s influence in driving social and environmental change at scale. The VentureESG initiative is an example of such a collaboration effort and has so far helped to educate and support hundreds of funds. This is fully aligned with Pitango’s mission.
As a result of our efforts, we believe we are setting the tone for the venture capital industry to include ESG across the industry’s processes, resulting in the creation of technology solutions to global challenges and a more inclusive, just, and sustainable economy.
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, fill in this form, or drop us an email at hello@ventureesg.com.
