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The growing emphasis on sustainable, socially responsible and mission-related investing has raised expectations for middle market private equity fund managers to show greater transparency on environmental, social, and governance (ESG) issues. A push for ESG policy development and reporting of financial and nonfinancial issues is apparent in ongoing portfolio management, as well as in M&A due diligence for both buy-side and sell-side transactions. This equates to smart business, as there is overwhelming evidence having a strong ESG proposition can increase a portfolio company’s valuation.

The prioritization of ESG by private equity firms is happening organically too, as investment managers realize the business value of tracking ESG for raising capital and attracting top diverse talent, according to �����ܹ�ͼ’s ESG advisory services practice. More general partners (GPs) are voluntarily becoming signatories of internationally recognized commitments, such as the United Nations’ Principles for Responsible Investment (PRI), as a public pledge to include ESG factors in investment decision-making and active ownership.

“Private equity funds that want to differentiate themselves in today’s increasingly competitive market should focus on aligning their investment practices with ESG goals,” says Anthony DeCandido, a partner in �����ܹ�ͼ’s ESG advisory services practice. With so much riding on outcomes, it may be worthwhile for middle market fund managers to create a custom playbook for their firm. While it requires commitment and there are many considerations, the potential impact cannot be underestimated.

“GPs who can articulate ESG best practices and show how they are walking the walk, meaning embedding it into the firm’s core business activities including corporate culture, will be viewed as influential leaders in the industry and more attractive to institutional investors,” says DeCandido, who is also financial services senior analyst at the firm.

Develop an ESG strategy with end goals in mind

Jake Salpeter, a supervisor in �����ܹ�ͼ Canada’s ESG advisory services practice, says the first question private equity groups must address is, “Why are we doing this? A firm’s ESG initiative should reflect the end goal, whether the focus is compliance-driven strategy transformation, aimed at attracting top talent to the firm, or keeping in step with relevant industry best practices around ESG.” 

ESG considerations for PE funds

Each fund will have its mix of ESG issues, ranging from employee matters to responsible investing practices and more. Here are common areas of focus for PE managers:

• Employee flexibility needs
  • Enhanced flexibility support and launched flexibility coaching
  • Expanded eligibility for self-managed time off
  • Flexible summer transition
• Career growth
  • Promotions
  • Continuing professional development and education reimbursement
• Remote or flexible work environment
  • Health certifications, return to office policies and PPE for safe and healthy work environments
  • Technology and innovation to enable remote work
  • Office hoteling
• Recognition
  • Gratitude meal boxes
• Financial security
  • Bonuses paid
  • Promotion base
  • Retirement plan and/or profit matching
• Physical health
  • Premium holidays
  • Telehealth services
  • Gym membership and/or fitness stipend
  • Employer-paid health benefits and/or waived out-of-pocket costs for COVID-19 testing
  • Healthy meals
• Mental wellbeing
  • Counseling, coaching, meditation and mindfulness resources
• Family support
  • Back-up child care and elder care
  • Virtual learning and tutoring resources
  • Childcare services
  • Nursing stations in the office
• Workforce
  • Diversity, equity, and inclusion policies and programs
  • Business ethics
• Data security
  • Secure printing
  • Digital records policies
• Environment
  • Essential travel policies
  • Mass transit and parking reimbursements 
  • Reusable bottles and cups in the office
  • Office composting
  • Motion-detected electric and water usage in the office
• Investing
  • Responsible investment policies
  • Systemic risk management

Knowing what drives key stakeholders is a good first step. Fund managers can leverage tools such as stakeholder mapping to identify internal and external groups and their level of influence. Creating a visual representation makes it easier to develop a holistic communication plan aimed at getting everyone aligned.

“Whatever the key drivers are, they will play a vital role in helping determine the outcome of the fund’s ESG journey,” adds Salpeter. 

Each fund will have its mix of ESG issues but a common area of focus for PE managers is to deliver effective employee benefits. A holistic well-being strategy should take into account physical, mental and financial health to help employees achieve work-life balance, the meaning of which is constantly evolving.

For instance, sustainable living trends have heightened expectations for employers to provide greener office environments. Greater emphasis on workplace fairness has given rise to diversity, equity and inclusion policies and programs. And for a growing majority of professionals, the work itself needs purpose, which underscores the value of establishing responsible investment practices, transparency and fairness.

As fund managers start to consider ESG opportunities, they should try to connect them to current priorities. Chances are the firm is already doing some of these things, which can lead to quick wins if these efforts are enhanced and promoted as part of the fund’s ESG story to stakeholders.  

Build an ESG framework that is personal to your organization

There is no one-size-fits-all ESG reporting framework. Ideally, the framework a firm chooses should enable the organization to achieve strategic business goals in alignment with its corporate values. Fund managers should not be overly concerned with checking the box for every ESG element, as it is far more important to focus on the factors most relevant and meaningful to stakeholders and which drive the greatest performance and societal outcomes.

It may be helpful to reference available reporting frameworks as a starting point and then evolve the firm’s ESG strategy from there. For example, the Sustainability Accounting Standards Board (SASB) provides guidance uniquely tailored for investors. SASB standards are industry-specific and metric-driven, and focused on financial materiality, which makes them valuable for integrating ESG considerations into investment and stewardship decisions across the enterprise. 

Encourage ESG engagement to ensure program alignment

As the connection between investing and value creation becomes more accepted, efforts by the private equity industry to integrate ESG into core business activities at both firms and their portfolio companies will continue to increase. 

“We’ve heard from private equity clients that the internal push to establish ESG programs has been in part grassroots driven by millennial staff members because of their generational mindset geared toward social and environmental consciousness,” Salpeter says.

He recommends for fund managers to take a bottom-up approach to collect perspectives around ESG priorities. Better yet, assemble a task force of cross-functional team members to identify and evaluate risks and opportunities, with a focus on long-term value creation. Having equal representation across the firm will ease program alignment and drive more successful ESG outcomes. 

Measure ESG performance to determine success

“The adage ‘what you don’t measure you can’t manage’ certainly applies to ESG program management. What makes it particularly challenging is there are no uniform reporting requirements, so it’s imperative to benchmark within the company, amongst its peer group, and within the industry it operates in,” says DeCandido. 

Of course, outcomes don’t matter if they aren’t communicated to stakeholders. Fund managers should leverage the power of branding to distinguish themselves from competitors, starting with ESG reporting. Best practices include building a strong mission statement, setting metrics to show what matters to your firm and sharing successes. 

“The importance of telling your ESG story cannot be overemphasized, and there are many different vehicles and voices that can be leveraged to help spread the word, including your own employees,” says Salpeter. “It’s extremely valuable when GPs promote stories through press releases, investor communications, their websites or within an ESG report. Having them socialize with their communities gives authenticity and power to the message.”

Published by PitchBook in the .