How ESG Investing Can Benefit Private Equity Firms

Environmental, social, and governance (ESG) investing is becoming more popular among individual investors and investment firms alike. There are several reasons why ESG is gaining in popularity. But what can ESG investing mean for your firm?

Let’s take a look at what ESG criteria there is, and why private equity firms are taking it seriously for their own portfolios.

What Are Environmental, Social, and Governance (ESG) Criteria?

Companies that meet ESG criteria are evaluated based on a number of factors. These attributes are a great way for investors to find companies that match their values. 

Most companies don’t meet the criteria in all three categories. Rather, they typically focus on one or two areas within the broader scope of ESG.

  • Environmental criteria can include factors such as a company’s energy use and where the energy comes from (renewable vs. fossil fuels), pollution, conservation, and their treatment of animals.
  • Social criteria involve the company’s relationships with its employees, local community, and other stakeholders. Social criteria considerations also include a company’s supply chain—whether the company’s suppliers and/or distributors hold the same standard of social values as the company itself.
  • Governance criteria relates to how transparent and fair a company is in governing itself. Reviews include factors such as transparent accounting and HR methods, stockholder enablement, and avoidance of conflicts of interest. And, of course, that the company doesn’t do anything illegal.

While some companies perform quite well in each ESG category, most commonly a company will excel in a particular area that is most important to them and where they direct more of their attention. 

It is up to the investor to decide which value is most meaningful to them when making investment decisions.

The Rise of ESG Investing

ESG investing is becoming more popular with PE firms for multiple reasons. First, investors themselves are becoming more interested in investing in their values (read Why Firm Culture is Important for Limited Partners). 

This is particularly true as Millennials begin to make up a bigger portion of investors, and Gen Z adults, who have not entered investment markets quietly, continue to build this trend. Therefore, PE firms need to be prepared to align with the values and investment desires of their clients.

Secondly, firms are increasingly viewing ESG investing as a way to avoid a variety of risk factors that impact company profitability and investor return. A company that consciously works to decrease its impact on the environment will, in theory, produce sustainable, long-term growth. This type of organization is also less likely to have to deal with a significant environmental disaster, which can cost billions of dollars.

Take the BP oil spill as an example. The Deepwater Horizon disaster occurred in 2010. In 2014, a U.S. court found that BP was primarily responsible for the disaster due to negligence and reckless conduct. By 2018, the incident had already cost the company $62 billion in cleanup costs and penalties.  

Both the environmental and financial toll could have been avoided if BP had been more focused on good corporate governance and better environmental practices. There are many other examples of companies that have cost themselves and investors millions or billions due to poor environmental, social, and governance values.

Finally, ESG investing can help improve firm culture, a key factor in overall financial success. Employees are becoming more concerned with who they are working for and the impact that the company’s work has on the world. 

Talented professionals want to have a positive impact on the planet and are increasingly pursuing employment with companies whose values align with their own. Developing a strong, values-based culture in your own firm will help you hire and retain top talent in the long run.

ESG Investing: A Higher Priority for Today’s Investor

ESG investing isn’t necessarily new, but it is becoming more imperative for investors to make it a priority. Basing investment decisions on ESG requirements is a good move for PE firms that are looking to attract new investors to their firm. It’s also a great way to mitigate risks and build a strong company culture. 

At a minimum, you should take a look at your firm’s investment portfolio and values to take stock of how your investors and firm could benefit from starting or increasing ESG investing.

A traditional crm was built for general ‘customer’ scenarios

Software platforms have made the world a better place by making work a better place. Indeed the world is better off when people enjoy their jobs even marginally more, and workplace applications on big CRM platforms like have done that and much more.

But the potential that platforms like these offer presents diminishing returns: once the platform provider has engineered too many industry specific components into its platform, its usefulness for other industries begins to be threatened, and with that so do the usefulness of the component tools built into the platform.

So it is with the CRM category that has defined: it is generic enough to work for many industries, and yet still offers the potential for others to round off the edges and nail more vertically-oriented and extremely tailored software solutions.

Private capital markets are actually a great demonstration of this dynamic. Where generic CRM platforms simplify — appropriately so — to assume there’s a business, a customer, a sale, and service of that customer, there are a few industry-specific pieces that are missing.

Take for example, that investors become customers by investing through legal entities the GP raises. It’s a subtle but important nuance that just doesn’t make sense at a platform-as-a-service level (because it’s overly complicated for a simple one-time sale that many industries require), but which can easily be added without 10 years or software engineering. Once provided, the rest of the platform’s components become tremendously powerful again and you’re set to take over the world.

As a traditional CRM in our pillars methodology, these nuances must be present to properly account for investors in these legal entities, potential target companies and which are owned by these entities, the context of all interactions with these parties (as well as the appropriate overlap, ie co-investments), and how you’re arriving at finding these opportunities on both sides of the equation, such that you’re able to piece together what’s effective and what’s not. Not just because we say so, but because these are the very relationships and data that are key to the motivation behind a CRM in any industry.

It’s critical, too, that the valuable publicly-available information that helps to enrich CRM systems and save users painful steps of entering it themselves is fully-integrated at the platform level.

Again, look no further than the 3,000+ pre-built integrations that — the creator of the CRM platform concept — has at a platform level to do so, and which only exists by way of holding just short of overly-specifying certain industry workflows that would present challenges to properly integrate.

Stakeholder reporting and communication (investor relations) draws on a range of datasets

The traditional “customer service” model of CRM systems once again makes overly-simplified assumptions about the customer relationship when applied to private capital markets.

In fifteen years I personally have yet to hear the terms “warranty” or “service call” in this market because it’s just not the same. But make no mistake, as uncomfortable as it may be to say aloud, customer service is more important now than ever and it’s constantly happening; the industry is, after all, considered to be a financial “service”.

As it turns out, that service is primarily information-based — it’s driven by data and takes the form of reports and analysis that drive decisions, and then end up again in investor-facing reports and analysis.

The foundational elements of a private capital markets CRM must be built such that they accommodate this data (like we discussed above), but so too that it can accommodate additional supporting data that investors (customers!) need in the context of service.

Oftentimes this supporting data — financial metrics and time-based values, for example — is believed not to meet the traditional definition of CRM and the natural thought is “well, better do this in Excel!”.

While I happen to believe Excel is still the greatest software application ever built, its introduction to this value chain we’ve discussed herein actually creates the problem many firms suffer from: key data needed to provide customer service (again: effectively the entirety of a firm’s reports and analysis) is now in disparate systems and detached.

Both of those dynamics are important and distinct: not only is this supplemental data disparate, but when brought together there is no logical association that can be made between the two data sets.

Allow me, then, to make the point very simply: not only can this financial and time-based value data (you may be thinking about is as “portfolio monitoring” or “accounting”) be a part of a CRM, it is arguably the most important part of a CRM because it’s at the core of what providing service to the customer entails — information that comes out of data!

Firms need a digital method to engage stakeholders (ie investor portals)

Investor portals are not new; in fact, for many of us — including myself — they conjure up horrifying nightmares in which we’re aimlessly guessing at folders to find the newest document we need.

So in lies the opportunity: not only have the portals we’ve come to hate not simplified the process of acquiring information, they’ve failed to create an entirely new experience that is “customer service” driven.

To be fair, this is not a B2C market where you’d be long out of business for not having focused on customer service and thus the customer’s technology-driven experience. But don’t expect to be around too much longer if you aren’t thinking about this shift.

Today’s institutional investors increasingly expect this same consumer-like experience, and a massive opportunity is being missed by not providing it. It’s not about providing them the experience they desire; it’s more about the ability to measure engagement that is had in return.

Put simply: what’s keeping the market from providing this experience is the availability of the information that’s required to create the service that provides the experience.

If you’ve hung in this long, you know that by focusing on your CRM, you have the data that’s required to manage the customer relationship and the technology-driven experience through which that information is shared to create a differentiated and opportunistic customer experience.

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