Why we need ESG to scale impact — If impact is the “why” then ESG is the “how”
If “impact” is the why, then “ESG” is the how. Impact Investors also need to be ESG managers.
It gives me great discomfort when I see the argument against ESG from impact investors.
Sure, ESG might also be the framework used by the ‘dirty assets’ (oil & gas, tabbaco, etc) to claim their stewardship towards environmental, social and governance positivity. That, on the surface, sounds like hypocrisy; how on earth could polluting companies be associated with supporting the environment (hence: ‘greenwashing’). Most seems like a PR story to help bad companies ‘polish’ their reputation and for investors to up the values of the investments. Perhaps that’s why some impact investors completely deny the concept and do not want to be associated with the term.
But the concept of ‘ESG’ is not to be confused with ‘impact’, especially in the world of investments. The terms have been used interchangeably and confusions still remain about the meaning.
/ESG/: is a set of ‘standards’ that measure how well corporations manage their relevant environmental, social and governance issues.
It is a standalone framework that can be used by anyone, any company and in any industry — regardless of what they do.
Thus, it is used as the lens to evaluate the companies’ risks and opportunities beyond their balance sheet (*the non-financials*). The best analogy I have heard of ESG is that if financial information is the rearview mirror, then ESG is like the side view mirror. It gives information about the same company but from a different angle. Can you drive without the side view mirror? yes. But that also increases the chances of unexpected incidents.
So by this definition, having a perfect ESG rating does not necessarily mean that the companies are creating a positive impact on the world. It just means that they comply with environmental regulations or set targets for reduction (e.g. emissions, waste management), support the people (e.g. worker safety, supply chain, diversity) and have good corporate governance (e.g. ethics, transparency). This is why you see companies like the tech giants Microsoft, Salesforce, Accenture, etc. consistently being rated as “ESG companies”*
So let me repeat this, ESG ratings do not reflect or measure a company’s impact on the earth and society.
/Impact/: on the other hand, is directly tied to the companies’ ability to explicitly solve the social or environmental problems, whose products and/or services are working towards positive change.
This is the investment strategy and it’s all about setting the intentionality (impact targets) to achieve a tangible and measurable positive outcome while generating financial returns. Unlike ESG, “impact” is all about what a company does and how it impacts the world.
But “impact” only measures the ‘outcomes’ but does not touch the ‘how’. Some impact investors may decide to measure workforce diversity (# of women, etc), which overlaps with the “S” in ESG but generally doesn’t capture or measure corporate governance or other operational conduct on environmental and social considerations.
So why both impact and ESG?
I’ve spent my entire career in ‘impact’: from launching a social enterprise to make it easier for people and corporates to make ‘impact’, to mainstreaming the UN’s SDG framework, and launching impact funds. Looking back, it has always been about redefining the role of businesses to create positive outcomes for the world. For the past years, I’ve worked with early-stage impact companies on their growth strategy, particularly those seeking venture capital investments.
If “Speed and Scale” is the recipe for success, we must not lose sight of the moral, ethical, or legal boundaries. Otherwise, we end up as a company that solely focuses on creating ‘impact’ in their respective domains but at the expense of others. which is why I believe you can’t truly scale or impact companies without incorporating ESG.
Take Theranos, for example; a company set out with the ‘intention’ to make a significant ‘impact’ with the vision to revolutionize medicine and save lives worldwide.
The downfall provides an excellent example of a failed ESG management due diligence from investors (in particular S, and G) The scandal is all about unethical behaviour, lack of transparency and code of conduct (G), and the culture of extreme secrecy, intimidation and fear (S).
In case you missed it, the company did the opposite of “changing the world”. Instead, it endangered health and lives by misdiagnosing tens of thousands of patients with serious health conditions like prostate cancer, miscarriage, etc. The unethical corporate culture, secrecy nature, and lack of whistleblower protection caused its employees to fear trauma and eventual death. And, of course, the lack of any rigorous due diligence left investors high and dry (~$600M, to be precise).
Is it right for a company to proclaim it will make a significant impact on the world but will scale that at all costs? Should we prioritize scaling at all costs for certain positive impact outcomes? Should we ignore the employees’ working conditions or ethics in entrepreneurship because we have the solutions to ‘save the world? Should we electrify our vehicles to fight climate change but at the expense of communities and our ecosystem?
Impact companies shouldn’t be excused from social or environmental responsibility because there is a solution to ‘save the world. They must consider both social and environmental factors, not one at the expense of the other. And they must do this across operations and business models.
You need BOTH impact and ESG to commercialize solutions that will solve the world’s biggest problems.
There is no need to have a ‘team ESG’ or ‘team impact’.
That’s like comparing apples to oranges.
Both are fruits, but they are not the same!
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My impact career led me to become an ESG Partner at UpperStage.Capital. We combine impact investment principles with ESG management to scale impact companies to their next level of success. This means that we look for companies making a positive impact on the world, while at the same time using the ESG toolkit to ensure we are growing our companies the right way. We are both thematic impact investors and ESG managers.
This journey is also far from being done. The field is constantly evolving, and new data and evidence are emerging about both impact and ESG matters. I am hopeful to see that social and environmental goods are finally converging with financial interests and that this may finally be the era where ‘impact” and “corporate responsibility” is no longer a nice to have but a must-have.
