A discussion with our Head of Business Development
ESG investing isn’t just due to the kindness of people’s hearts. It’s a solid investment philosophy that can help investors mitigate risk.
Hannah Leach is the co-founder of VentureESG, a community around ESG in venture. The group helps venture capital (VC) firms integrate ESG practices into their end-to-end processes. This is a new initiative within the venture landscape and has been gaining traction in the recent months. Hannah is also a Partner of Houghton Street Ventures, a venture capital firm founded in partnership with the London School of Economics (LSE).
When I finished my undergrad, I went to work for a public affairs company in London. I was working with big companies on Corporate Social Responsibility (CSR) campaigns, but a lot of it was really the epitome of greenwashing. It wasn't looking at doing anything proactive, rather it was trying to cover up their negative behaviour. I was really disillusioned by that and went to work in India for the philanthropy foundation arm of a big bank. There, I continued to do CSR work, but at the same time, I was exposed to organisations like Acumen Fund. These organisations were engaged in impact investing, they were looking to actually invest in companies that were doing good. It was through that, that I became aware of using the power of business to solve global challenges and global problems. Whilst I never actually worked directly in impact, it has always been an interest of mine; I've tried to weave it into everything I've done. With this in mind, I worked for a data ethics consultancy a few years ago. This work included supporting early-stage companies with thinking about how they handle consumer data and how they could be more transparent with the user. All of these experiences have made me aware of what it means to be a responsible business and for businesses to have a positive role in society.
Mainly, we are raising a venture firm in partnership with the London School of Economics (LSE). The LSE ethos is deeply connected to the social sciences and humanities; when we looked at how that applied to us, a new VC fund, in terms of investing in and supporting businesses, we saw this as ensuring that our investments go into businesses that view their role in relation to their impact on society and the planet. We want to support businesses that are encouraging positive behaviours and taking care of their broader stakeholders. To begin with, these businesses would not be looking at the external impact or outcome, but rather, looking at whether they're operating and growing in a responsible, inclusive and sustainable way, contrary to investing in blitzscaling unicorns. We saw this as taking an ESG approach and we started researching what ESG could mean for VCs.
“As arbiters of capital at the super early-stage, we have a responsibility to keep these businesses accountable. We want to help and support them to have the right processes in place. Because if we're not going to do it at that point, it will become more and more complicated as businesses grow.”
As startups expand and become big tech, practices and cultures can get out of hand, so it will become a lot harder to have them realigned. We want to play a part in instilling those strong practices, behaviours, values and foundations at the beginning of the startup journey.
We’re not even at the point where we're thinking about metrics; that’s more where public markets are in terms of ESG. There are ESG rating agencies for public equities which produce - unfortunately often still confused - ESG ratings. For early-stage companies, it’s a different ballgame. We seek to understand what issues are actually relevant for them, so we go back to the very beginning. We started this community because we felt that all of the existing frameworks and processes in public markets and late-stage private markets weren't really relevant for early-stage companies.
“The existing frameworks weren't capturing everything around the new nuances and challenges that startups face. Particularly around privacy and security; these new challenges include how to build responsible products in terms of adverse impacts and responsible AI.”
Things that are unique to startups include the fast growth in HR, the team, and the working environment. These are the issues that matter to diligence and in portfolio management. Only 10 to 12 months in are we actually getting to the point where we're thinking about metrics. When you're investing and doing due diligence on very early-stage companies, there's not a lot you can quantify, a lot of it is more qualitative.
We want to find out and influence how founders think and make sure they’ve thought through the adverse impacts. We ask, ‘How are they mitigating unintended consequences?’ ‘What are their attitudes in terms of scaling their business over the long term?’ ‘What are their attitudes on their environmental footprint?’ ‘Are they thinking about their employees' mental health, and how to incentivise and motivate them?’ That's the key due diligence that you're doing at that point.
While we don’t have a standard framework yet, we are keen to provide a view on what we think of the ‘universe of issues’ that matter in ESG for VCs and startups in a second step, we need to keep both firms and companies accountable and get them to report a certain set of metrics and KPIs. But that’s in the medium to long term.
When we started this a year ago, there were very few VC firms who were thinking about this. Maybe some funds had an exclusions list where they listed out what they wouldn't invest in or what they would avoid. But there were very few funds that were putting in place proactive ESG processes either on due diligence or portfolio management.
“Now, ESG has come to the forefront of business practices also for private market investors; I think that's driven by a few things. One is limited partner (LP) pressure; LPs are asking funds more about their ESG processes, which is causing funds to think about it internally in regards to regulation. In Europe especially, it is driving asset managers to think about their processes and what they have in place.”
Then there's consumer pressure and founder pressure. Founders are now looking for venture funds who are more value-aligned. If funds see that as a differentiator in order to win a deal, then that’s positive and also a differentiator on the LP side.
There’s also been some very large public fallouts in big tech and beyond. Employees within big companies are finding their voice and holding their companies to account. Brewdog is a recent example. Really, it's a confluence of all of these factors that are driving change and behaviour change in venture capital.
“The industry in general is driven by a ‘fear of missing out’; if a number of funds are doing something, then the attitude is ‘I need to be doing it too.’ This will also help to drive ESG into VC.”
Whilst we have built this community of 130+ funds, there is currently no accountability mechanism in place. There's no pledge and there's no commitment. But in time, that's what we want to roll out. By being part of the VentureESG community, we are committing, as a fund, to implement X, Y, and Z and a report on X, Y and Z.
It's very hard to look for certain things at the super early-stage. It’s more around founder intent and the way they are approaching these types of issues. But before that, when you're screening a company, you can look for inconsistencies with ESG and within a business model. If a business is relying on a supply chain or low paid labour, or using data in the wrong way, or if they’re exploitative, then there are certain red flags to look out for that we would call out. But if there's no obvious inconsistencies, then it’s more talking through the business model and talking with the founder to see how they're thinking about ESG in their business operation. That's more of the due diligence point.
In portfolio management, it’s more about working with the founder to identify their blind spots; this could be their business priority or it could be the things that they hadn’t thought about. It includes going through the list of ESG issues and what is material to that business, given its stage and sector. We’ll work with that founder to help them set KPIs and targets, which would be reviewed on a 3-6-month basis or a quarterly or annual basis.
“At this point, it's not a matter of getting a founder to tick a box, it’s really about supporting them. We’ll support them through providing access to resources and best practices, we also highlight company peers in their sector doing an equivalent ESG process.”
The extent to which the community has grown in the last six months is fantastic. A whole array of funds are now involved and committing their time and energy.
“It’s wonderful that funds are hiring expertise into their teams and actually building internal capacity around ESG. Because that means it’s something that they need to do, they're not outsourcing it. It's also not a tick box exercise, they're really keen to embed it into the fabric and the DNA of how the fund operates.”
I think that demonstrates long-term commitment to ESG within the fund. It’s also great to see the extent to which founders get excited about this. We see founders who really believe in what we stand for and who want to scale their businesses in this way. It gives me a lot of hope for the future.
Like all of these things at the early-stage, we need to make sure that it's not a bandwagon that people are jumping on, which it has the propensity to be. We need to think clearly about what it means in terms of accountability over the long-term.
“For venture, we want to get consensus around the meaning of ESG in practical terms, so that as an industry, we can hold one another to this shared understanding.”
At the moment, it's a bit of an amorphous concept. If you're starting at the very beginning, and you don't really know what it is, then there's not that much information out there; there are no clear guidelines and toolkits. People talk about it, but they don't talk about it in practical terms. To get people engaged and advance internal fund practices around this, we need to establish very clear guidelines around what it means if you're a pre-seed fund, a seed fund - Series A or Series B - and what it means if you’re a company. We need to be clear on what funds and companies need to do at each stage. They need to be aware of what they need to report; providing people with all the resources would make it simpler to understand. However, at this point in time, that's not happening.
Secondly, and perhaps more importantly, there's no data. There's a cohort of venture funds, like the ones that we're working with, who really believe that reporting and having quality internal policies are drivers of long-term commercial value. But then there are funds who say ‘Show me the data fast.’ We currently don't have that data.
“But I think that in the next 5-10 years, if we can start to get some data on ESG and venture, and demonstrate that it does drive commercial growth, then it will move the industry forward. That's not going to happen for a while, but if we can start to surface that data, then that would be helpful.”
I don't think it's necessarily a concern, it's more just making people aware of the whole gamut of issues that ESG encompasses. Today, the conversation is very much focused on Diversity, Equity and Inclusion. I think it's easy for people to focus on one thing and do that well and then expand, but we need to make people aware that there's not just one or two issues. The things that I mentioned before such as building a responsible product, recognising bias, and being aware of diversity, are things of which people often aren't aware - so they don't engage. Education is needed to ensure that people are aware of all of the issues, they can then draw out the best practice. It’s good to be aware of examples of where things have gone wrong. For example, Lemonade, where their customer data was exposed. If we can point to examples where things have gone wrong in high growth companies, then that can give an example of what to avoid and what not to do.
ESG is probably not the right term. Other companies have re-termed it. For instance, Atomico calls it ‘Conscious Scaling' and have had their framework around for a long time. You have Kindred Capital who are working on their framework called ‘Responsible business.’ We've also got Balderton, who have their ‘Sustainable Future Goals.’
We’ve used ESG because it's well known in the business world and it makes people listen; it's a good reference point. But we need to think about how we change the terminology so that we can help founders understand why it's important for them at the very early-stage. The natural pushback that we receive from startups is that they are very focused on growing their business, or fundraising, or hiring, so they don't have time to think about ESG or anything of the like. We need to move that conversation and actually embed it in the way that the business operates. It's not an add on, it’s something that you need to do from the start.
“If you're hiring, you need to do that in a diverse and inclusive way. If you're building a product, you need to make sure you've considered the adverse impacts and how it can be accessible and inclusive. It should just be integrated into the way the business runs. We don’t spend enough time thinking about the language needed to make that the case.”
Once they get past the initial name of the framework, then they should understand that the issues we're focusing on are very much the same. But yes, if I have three investors, and they're onboarding me, taking me through this ESG framework, and asking me to report, then that's a waste of time. So, getting some consensus within this community around what is important, will make it simpler and prevent some of that duplication. But this requires VC funds to work together - that is what we are trying to do at VentureESG, take some of the competitive edge out of the industry, at least in this respect.
Whenever we talk about ESG, we often fall into a conversation around ESG and impact, and a lot of people conflate the two. That limits our ability to get to the nitty gritty of what ESG means and why it's important.
We spend a lot of our time reframing the conversation from the beginning. We clarify what ESG is, what impact is, and how they're different. There's sometimes a misunderstanding on the LP side and sometimes a misunderstanding on the fund side.
Balderton is a really good example. They’ve adopted their ‘Sustainable Future Goals’ which are about sustainable development goals (SDGs) and ESG. For us, SDGs are more impact aligned. The two need to be treated as separate processes, they’re not mutually exclusive but internally, you need to have different processes to account for both. I think that lumping them into the same category is a disservice to both.
If any venture funds are thinking about their approach to ESG and want to become a part of the community of more than 130 funds globally, then reach out to firstname.lastname@example.org.
The multi-national brewery has been accused by former staff of fostering a ‘toxic culture.’ Ex-employees signed an open letter to the company outlining incidents of being bullied and treated like objects. The letter included claims that since its recent rapid growth, Brewdog has been cutting corners regarding the health and safety of its employees.
The insurtech firm recently faced scandal in May for having a security flaw in its website that potentially exposed customers’ data. These allegations came from the activist investor, Muddy Waters Research LLC.
ESG investing isn’t just due to the kindness of people’s hearts. It’s a solid investment philosophy that can help investors mitigate risk.