The path to an IPO is not simple. It requires significant time, cost, and effort. It’s become even more complicated in recent years. This is because many investors no longer solely rely on financial metrics and market potential to assess investment viability. Companies need to commit to operate in a responsible and sustainable manner in order to deliver value over time.
But what is ESG?
The acronym “ESG” stands for Environmental, Social and Governance. It helps evaluate the impact an organisation has from an environmental, social, and governance perspective. Organisations who abide by ESG standards commit to ethical conduct in those three areas.
EY lists a sample of issues associated with each letter in the acronym:
- Climate change and emissions due to operations
- Energy efficiency
- Optimum utilisation of raw materials and water resources
- Waste disposal
- Biodiversity protection
- Data protection and cyber-security
- Community relations
- Social development
- Employee well-being
- Human rights
- Community involvement
- Company culture, structure, policies and processes
- Ethical operations
It is important to note that ESG issues may differ across industries and businesses. A software company might be more strongly-focused on the social aspect of ESG, paying close attention to data privacy and security. While a company in the building materials industry might concentrate on environmental considerations.
6 Reasons Why ESG is Crucial Pre-IPO
ESG consciousness is increasing.
The organisations who choose to acknowledge this early on in their IPO journeys become more credible in the eyes of investors.
Here are other reasons why ESG is critical for companies preparing for an IPO:
1. Investor Expectations
According to RBC, sustainable investment comprised 36% of total global assets under management (AUM), or more than US $35 trillion, in 2020. This figure is expected to grow.
Sustainability-focused investors pursue investments that align with their values and drive positive change. They look at ESG metrics to support their investment decisions. There is the significant risk of leaving these investors on the sidelines if there is no early strategic approach to integrating ESG. It can play a critical role in the company’s valuation process.
2. Employee Engagement and Retention
ESG can help attract and retain talent, the organisation’s most valuable asset.
The same EY paper referenced above states that millennials and Gen Z are among the largest generations that seek “purposeful” job opportunities. They care about who they work for, and what their employers stand for.
Having a corporate mission that resonates with employees’ personal values can foster better employee productivity and engagement, less attrition, and motivate teams to execute corporate strategy that meets investor and stakeholder expectations.
3. Developing Regulatory Requirements
Regulatory requirements that impact sustainability are expected to increase over the next couple of years. Some are already in place.
For instance, the EU’s Sustainable Finance Disclosure Regulation, which came into effect in March 2021, requires financial market participants operating in the EU to disclose sustainability-related information to ensure that investors have the data they need to make informed decisions.
There is also the proposed EU Corporate Sustainability Reporting Directive which will build on the Non-Financial Reporting Directive and extend reporting requirements to a wider set of public companies, including small and medium-size listed companies.
All of this is to say that the sooner pre-IPO companies can start working towards a reporting and disclosure process, the more prepared they will be to meet these regulatory requirements once listed.
4. Stronger Brand Equity and Market Reputation
When ESG reporting is communicated effectively, it can serve as a powerful and convincing brand management tool for companies. Pre-IPO companies that engage in providing value for all stakeholders not only build trust, but also help create a positive market reputation when it comes to their approach towards sustainability. In other words, it helps firms leverage their reputation when going public.
5. Financial Impact
The financial metrics attributed to ESG performance are not to be scoffed at:
“According to RBC CM research, S&P 500 and S&P Europe 350 companies with better ESG risk profiles have outperformed those with higher ESG risk over time on a sector-netural basis….Companies with the best ESG risk profiles tend to have lower total return volatility, higher ROEs, and higher P/E valuations. Other studies have shown that companies with high ESG ratings have less systematic risk exposure, lowering investors’ required rate of return and the company’s cost of capital.”
Pre-IPO firms should realise the financial materiality of ESG reporting. The quality of ESG and sustainability disclosures can have a profound impact (financially) for the company.
6. Bolster Competitive Edge
It’s not only investors who are paying close attention to a company’s ESG practices — consumers are taking notice as well. Consumers expect companies to contribute to the betterment of society and be held accountable for their practices. They continue to opt for brands that allow them to invest in “sustainable innovations” that generate consistent returns long-term while resonating with their values and beliefs.
It’s important to note that consumers also penalise businesses whose operations are harmful to society.
An EY global study showed that 61% of respondents would be “less likely to buy a product if the company was performing poorly on environmental practices….59% of the respondents are becoming more influenced by the environmental impact of the consumer products they buy, 38% have boycotted food brands because of perceived bad environmental practices — a figure that reaches 48% among younger consumers.”
Private companies who are considering going public must take these into consideration for building a loyal customer base and managing profitability performance and expectations.
How to start the ESG journey pre-IPO
It’s not easy to jump head-first into implementing ESG principles in the pre-IPO journey. But the following steps might be a good place to begin.
1. Align company purpose with sustainability objectives
It’s crucial to meet stakeholders’ — not just shareholders’ — expectations when it comes to integrating ESG principles into the DNA of the firm.
One way of doing this is to embed these principles into the corporate purpose of the company. The difference between corporate purpose and a mission statement is that the purpose reflects what the company stands for, rather than what it provides or does from a functional standpoint.
The purpose should address the ESG impact of products and services, as well as how it will respond to sustainability challenges (e.g. climate change, systemic social issues, leadership accountability, diversity and inclusion, employee well-being, etc.) It provides answers as to how the company will deliver holistic value for all stakeholders.
2. Identify areas where ESG might intersect with business operations
It’s also important to understand where business operations impact ESG and vice versa. Asking the following questions can be a start:
- Do you know everything you need to know about how and where your raw materials or product components are sourced?
- Do you have diversity and inclusion objectives and processes for hiring/retaining employees and vendor selection? Do you measure your progress over time?
- Are you implementing sustainability enhancements across your operation?
- Do you have a proper board structure, including board members with a diverse range of backgrounds and viewpoints?
3. Understand who your stakeholders are and consider the investor profile you’d like to attract
Firms can’t do everything all at once. Gaining a true understanding of who will be impacted by the company’s practices, along with the investors the organisation wants, will help the pre-IPO company prioritise ESG initiatives.
4. Adopt a framework for measuring ESG performance
Pre-IPO companies should ensure accurate and quality ESG disclosures on its performance early on, so as to understand how to tell its ESG story and report its efforts.
By sharing the company’s sustainability strategy, companies aspiring to go public can attract the growing number of socially conscious investors. In addition, effective communication practices can add dimension to the value proposition of the company.
To Close —
Early stage and growing companies who embark on the ESG journey reflect and signal their resilience, responsibility and readiness before going public.
Levi’s, the clothing apparel company, had one of the most successful IPOs of 2019. Their CEO, Chip Bergh, puts the ESG focus into perspective: there is “hearty investor appetite” to support companies with a strong moral compass.
ESG-oriented companies do not have to make sacrifices in this regard.
Bergh seems to take this position as well:
“It is false to say we or any company must choose between business performance or responsible social conduct. The most successful companies do both.”