Editor’s Note: Authors Brad Ives, William Pleasant, and Tom Goodrum are the co-founders of the Triangle-based Credo ESG Solutions Inc which assists private companies and private equity firms incorporate, monitor, and improve ESG practices.

RALEIGH – North Carolina saw a 29% increase in the number of new companies formed in 2020, compared to 2019, according to the U.S. Census Bureau—marking an all-time record for our state. As North Carolina continues to attract a greater number of founders, startups and SMBs, private equity investment is following suit. In fact, a report from the Financial Times shows that, through the end of June, private equity firms concluded the most active first six months of a calendar year in the preceding four decades.

In the midst of this increased investor and startup activity, concerns about climate risk and social justice issues have added to the already complex landscape facing business leaders. For growing businesses to succeed and secure capital, it’s critical for them to truly comprehend ESG—environmental, social, and governance—concepts, the growing importance of ESG to stakeholders, and how to incorporate improvement of ESG performance into long-term strategies. Not only are customers and investors expecting it, but research shows companies that prioritize ESG improvement also create more value.

Since measurement, tracking, and improvement of ESG performance is a relatively new concept, it can be hard to know where to start. The good news for growing companies is that an early focus on ESG topics can lower risk while producing better financial returns and happier employees, customers, and investors.

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The growing emphasis on ESG is a net positive for society. We’re seeing business leaders think about their companies’ growth and impact in nontraditional ways, going beyond financial reporting and community benefit programs to adjust for issues like climate risk or a lack of diversity. An ESG framework also holds companies more accountable to customers, investors, the communities in which they operate, and society at large.

The movement couldn’t come at a better time. The recent report from the United Nations’ Intergovernmental Panel on Climate Change (IPCC) spotlighted that climate risks are expected to increase in severity and frequency over the next three decades. This means even non-public companies and their investors will need to assess their exposure to risks from physical hazards (like floods, storms, fires, drought — all extreme weather events that seem to be stealing the headlines lately) as well as transition risks (including technology, policy, consumer demand, and legal changes).  They should also consider what steps they can take to minimize their own impact – steps that can often provide tangible and intangible business advantages.

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Beyond climate risk, we also see other aspects of ESG that great companies need to incorporate:

  1. Use multiple lenses to view diversity in your workforce and board. Race, ethnicity, age, and gender are key factors to consider, but you should also think beyond demographic diversity. Part of a board’s mission is to steer a company toward growth by delivering on customer needs. To this end, it may help to ensure the customer’s voice has a seat at the table; for example, a health tech startup could bring on a patient advocate or caregiver as a board member.
  2. Hire an internal or external chief sustainability officer or other role dedicated to overseeing the company’s ESG initiatives. This role will be important to ensure the company is maximizing its positive impact on society and the planet, bringing ESG to the forefront of decision making, and keeping a pulse on federal, state and local regulations that could affect the business as well as investor and customer needs and interests.
  3. Embed resiliency planning into your business practices through socially conscious leadership and good corporate governance. This could incorporate ongoing assessment of opportunities to increase transparency or inclusivity, or securing backup suppliers/partners who can help customer fulfillment in times of difficulty. COVID-19 underscored the unpredictability of the business landscape, encouraging business owners to double down on strong governance practices and strategic planning that can maneuver past bumps in the road.

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Four ways private equity firms can bolster ESG strategies

Private equity firms, which can offer capital infusions and buyouts, are considering how to incorporate ESG considerations into their evaluations and models as well.  According to the Pitchbook 2020 Sustainable Investment Survey, 95% of investors in private equity funds are either already evaluating ESG risk factors or planned to increase their focus on ESG risk factors.

To do so effectively and efficiently, private equity firms may consider:

  1. Undergoing a portfolio-wide ESG risk assessment. This exercise will provide greater clarity on the types of potential risks, such as climate change, that the firm’s portfolio faces; the magnitude of the risks; the possibilities for moderating the risk; and competitive opportunities associated with the risk.  Such a review may also identify cost savings and ideas for long-term value creation.
  2. Encouraging a positive culture of ESG reporting and measurement. Companies will want to communicate the growing significance of ESG policies and gain internal buy-in and support across an organization. For private equity firms developing a new ESG strategy, a change management plan can help build enthusiasm for the initiative and emphasize how ESG enables a better culture while improving financial value.
  3. Adopting ESG due diligence practices for new investments. This type of review helps target short-, medium- and long-term risks and opportunities associated with ESG factors such as climate change, including operational challenges, stranded assets, and untapped areas for value creation.
  4. Turning the ESG spotlight on themselves. Investors in private equity funds are increasingly focused on well-integrated and holistic ESG strategies. This means that the private equity firm itself should examine its specific performance on ESG factors and create a framework for ongoing monitoring and improvement.

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EY’s 2021 CEO Imperative Study found that 80% of CEOs report that it is likely “companies will take significant new steps to take responsibility for the social and environmental impacts of their operations” during the next five years.

It’s clear that ESG presents an opportunity for companies and private equity firms as they approach their next phases of growth.

Entities that take strategic, intentional steps today will be able to demonstrate their value to investors, employees, and the community at large tomorrow.