The ‘G’ of ESG — The Unspoken Side of Governance in VC
In the latest of a series of collaborations, in early September, the World Economic Forum (WEF) and VentureESG convened leaders from across the VC ecosystem to a workshop focussed on the ‘G’ of ESG. This summary of key takeaways from the session was authored by Guillaume Hingel, Financial Innovation Lead of the Centre for Financial and Monetary Systems within WEF.
Context
The World Economic Forum launched its Venture Capital community in May at the Annual Meeting 2022 in Davos. The ultimate ambition of this community is to support and build healthy entrepreneurship ecosystems across the globe. To do this, the community has been focusing on tackling common industry-level challenges, as well as identifying opportunity areas to work together to promote a strong venture capital industry.
With VentureESG’s role and reach within this ecosystem, over the past twelve months, the Forum and VentureESG have been collaborating on a work-stream to bring together VC funds and LPs to drive forward discussion, debate, and ultimately action around integrating ESG into VC. This workshop is the second workshop in the Forum-VentureESG collaboration series focused on the “G of ESG”. The last workshop in Spring 2023 convened senior leaders from the VC industry in New York and focused on the responsibilities of LPs and GPs to embed good governance within their portfolio company operations.
This workshop focused our attention at the VC fund level, exploring the unspoken dimensions of governance, which have to date dictated a large part of VC fund behaviour. Increasing competition to win deals and pressure to maximise returns can often lead firms to make rushed decisions, potentially compromising ethical boundaries. Investors can compete to win deals in many ways; some give way on price, some give way on terms, others on governance and due diligence standards. How can we ensure that the G in ESG is given the importance it deserves and we build a more responsible and ethical venture capital ecosystem for the future? Is allowing for temporary ‘loose governance’ a necessary evil in the process of innovating?
Key Take-Aways
Importance of processes and documentation
A key theme was the importance of clear processes and documentation around governance decisions, minutes, terms of reference, and diligence procedures. This transparency enables consistency, accountability, and the avoidance of conflicts of interest. For limited partners (LPs), having a track record and an existing relationship with a fund provides comfort around governance norms and integrity. The contract terms themselves act as guardrails on governance. LPs emphasized diligencing the consistency between stated processes, like accelerated diligence, and actual actions.
Limitations of self-regulation
Some participants were sceptical that voluntary industry-led guidance would suffice to elevate governance. Clear regulations and laws provide less ambiguous guardrails where ethics may be more grey. LP’s auditing and performing oversight of VC governance is also challenging given fund structures. While VCs setting policies is important, participants emphasised governance is ultimately a collective responsibility between LPs, VCs, and founders.
Differences in norms between geographies
Perspectives differed on whether issues like lax diligence or information sharing are more prevalent in US or European VC. Some felt the US narrative of moving fast without diligence is overblown versus reality. Others highlighted that US VC has more established governance playbooks given decades more history. Overall, regional generalisations were seen as less useful than assessing each firm’s unique priorities and culture.
Ensuring integrity between narratives and actions
A key expectation from LPs is integrity between what VCs state in fund marketing and updates around processes, governance, ethics, etc. versus actual actions and behaviour. Any dissonance raises red flags on true priorities. Solutions include LPs holding VCs to account through reporting standards, LP Advisory Committee oversight, and being blunt in feedback. This enables course correction on governance issues.
Managing information sharing risks between VCs
Several participants highlighted the risks of sharing deal information and collaborating between VCs pre-investment. This can unfairly undermine founders’ leverage in negotiations. Protocols are needed to maintain confidentiality and independence given the incentives. Post-investment, information sharing via WhatsApp groups etc. is common to aid portfolio companies. But guidelines are still required given confidentiality issues between potentially competing VCs. One solution is focusing policies based on what is optimal for founders, avoiding compromising situations. Another is clearly delineating what information can and cannot be shared internally and externally.
Importance of whistleblowing capabilities
One governance gap raised was that formal whistleblowing policies are often lacking in VC firms currently, given the typical small partnership sizes. However, this is likely to evolve as firms mature, expand and onboard more junior staff. One solution proposed was training individuals at all levels on ethical practices, not just partners. Another was mimicking regulations and laws in designing internal governance policies, to remove ambiguity around issues like information sharing. Overall, building whistleblowing capabilities was seen as crucial for VCs as they scale.
Maintaining founder-centricity
One ethical dilemma raised was that VCs often take board seats in portfolio companies, creating a dual mandate — to their LPs as investors and to founders they have a fiduciary duty to. Resolving conflicts between these interests is crucial, and maintaining founder-centricity should be the priority. Solutions like avoiding over-boarding by VCs can help align incentives with founders.
Uneven governance maturity between US and Europe
Participants felt US VC has benefitted from decades more history, providing established governance norms and playbooks. New SEC regulations enhancing LP oversight are also elevating US standards. More collective wisdom exists compared to Europe’s younger ecosystem. However, issues like information sharing persist everywhere. Overall, US VC was seen as more mature in governance, but European VC is rapidly catching up.
Role of LP signaling on governance priorities
LPs play a crucial role in signaling priorities around governance, ethics, and transparency from the outset in manager selection, reporting requirements, and ongoing dialogue. Being clear on expectations with VCs on issues like information rights, side letters and conflict resolution prevents surprises down the line. LPs can nudge VCs to go beyond minimal regulatory compliance on governance.
Need for governance scaling playbooks
As VC firms scale, more junior staff get onboarded and partnership dynamics evolve, governance practices will need to mature. Workshop participants saw a lack of adequate playbooks tailored to VC, versus more established private equity governance norms. Developing these scaling playbooks earlier in anticipation of growth would help preempt issues.
Risks from informal sharing channels
Several participants highlighted how informal sharing channels like WhatsApp increase governance risks around confidential data. Solutions included more guidelines, training and internal transparency on appropriate usage. External messaging channels create additional risks of information leakage.
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.
