What do start-ups expect from venture capital funds when it comes to ESG?

Venture capital (VC) plays a transformative role in society given the nature of the disruptive business models and companies VC funds invest in. Even though these funds take up minority stakes in companies, that typically gets diluted in subsequent rounds of funding. VC funds through their active-engagement model can set the foundation for long-term and sustainable value creating companies.

In the past 18 months, many VC firms have realized this and are beginning to scrutinize their own Environmental, Social and Governance (ESG) strategies. There are some who are suggesting or even requiring start-ups to embed these considerations into their business activities.

Therefore, over the past six months, the World Economic Forum conducted a survey and interviewed start-ups from the Forum’s Global Innovators and Technology Pioneers communities. Respondents were asked to share their views about ESG and their expectations of VC funds when it comes to ESG. The findings have been published in the report ESG Pulse Check: Getting the Basics Right for Startups and Venture Capital Firms.

Here are three key insights for VCs:

Start-up founders are increasingly looking for ESG-related value proofs from their investors before bringing them onto their cap table. While the funding environment for start-ups is tightening, with a funding drop of 23% in the second quarter of 2022, start-ups are evaluating who they raise funds from in a more nuanced manner, including aspects such as commitment to ESG and how they prioritize various factors within E, S and G separately. In the survey, 64% of start-ups said that the sustainability expertise of investors is a factor when they think about fundraising.

VCs can use the power of their networks to identify key insights that can help portfolio companies effectively embed and deploy ESG strategies. The topic of education and capacity building was a recurring theme across the 45 survey responses, workshop and interviews, conducted by the Forum.

In addition, it is imperative for VCs to meet start-ups where they are in their journey. Starting small, for instance, by aligning on the one key ESG issue that the start-up has the potential to make a disproportionate impact on and building from there using the services that investors have to offer can add great value to both sides.

While ESG metrics can be a helpful way to gauge and alleviate potential risks for start-ups, investors must recognize that there is a significant gap in the supporting ecosystem of ESG benchmarks, relevant indicators, measurement tools, etc. In this scenario, levying onerous reporting requirements on start-ups can do more harm than good as these companies have limited resources to balance growth and sustainability.

During the Forum’s survey and interviews, start-ups mentioned the need for investors to be flexible and work with the companies to identify a small but material set of ESG metrics that fit with the company’s strategic vision. Further, these metrics must be chosen in a way that enables the next set of investors to also find meaning in ESG reporting. Many respondents also mentioned the benefit of VC firms sharing success stories of their portfolio companies to highlight qualitative insights about the progress of these start-ups.

To find out more about this topic, read the World Economic Forum's insight report ESG Pulse Check: Getting the Basics Right for Startups and Venture Capital Firms.