ESG investing: hope versus reality
As is the case with the implementation of many principled goals, especially from the financial community, there seem to be some difficulties between words and deeds, as is the case with ESG. ESG stands for environmental awareness, sustainability and governance. This means:
· Environment: are we doing what is right? for the environment?
Sustainable: is what we do good in the long run?
Governance: is what we do good for everyone?
DOES REALITY MEET THE HYPE?
Bloomberg BusinessWeek (5/9/2022, page 22) notes that there are a few snakes in the yard:
· Some arms dealers, who don’t follow ESG principles, manage to pass if guns only make up a small part of their sales. So being “little pregnant” seems acceptable.
· ESG ratings are developed by index makers and the process is opaque. Even though the “G” stands for fair governance, conflicts of interest seem acceptable to those who make the rules.
· ESG appears to be measured by the impact of a scarce resource on the business, not on consumers and the community. A company that uses a lot of scarce resources is acceptable if the company has enough of the scarce resources in its hands. Hoarding seems acceptable when the artificial scarcity and higher prices hurt society, but not the company.
IS VC CONSTANT WITH ESG?
Environment: Most successful VCs invest in high-growth industrieswhich are mainly emerging industries.
The problem: Are all emerging industries environmentally friendly? Can ESG VCs succeed without subsidies if they invest in eco-friendly industries?
Socially aware or elitist: The most successful VCs focus on financial returns, not social returns. High financial returns are often achieved by ventures started and run by entrepreneurs trained in the right skills, or by experienced entrepreneurs with an excellent track record. Entrepreneurs who do not meet these high standards are often replaced by experienced managers.
The problem: Can low-income community members without a pedigree institution in their background get VC from top VC funds? Can we teach everyone unicorn skills to take off without VC?
Governance is not a major VC priority. Poor governance principles have not stopped VCs from investing in companies. Mark Zuckerberg owns more than 50% of Facebook’s voting rights but owns less than 30% of the company. In fact, the founders of Snap are said to own more than 90% of its voting stock though they own much less. Both companies received VC financing. Verkada sells security tools, but there are questions about the company. According to TechCrunch, “Boy, investors have had to look away from a lot of supposed horrificness.” But that doesn’t stop VCs from using Verkada . to fund. So, is governance really important to VCs?
The problem: If it takes a focused focus on returns, not governance to reach the top 4% of venture capital funds, can limited ESG VCs enter the top 4% of venture capital funds? And if they don’t make the top 4%, will these funds get unsubsidized funding from the pension funds?
PLACING ESG VC FUNDS IN THE TOP 4%
VC is elitist because the institutions they fund want high returns. The top 4% of venture capital funds, which receive the most institutional funding, would earn 95% of VC returns in the US They earn high returns because they invest in the few home runs that offer high returns without worrying about ESG, which seems to be an afterthought and mostly for PR reasons. Without these home runs, VCs don’t make it to the top.
Can ESG VC funds achieve high returns and reach the top?
I’ve funded, interviewed and studied unicorn entrepreneurs (UEs) and worked with the most difficult form of ESG VC, which is with community development corporations (CDCs) targeting low-income communities and with the US Department of Health & Human Services who funded them, here are a few suggestions for ESG VC to seek a place in the Top 4% of VCs.
#1. Combine unicorn entrepreneurship (UE) and VC for more unicorns everywhere. To achieve high returns, ESG VC funds must actively create unicorns rather than passively wait for them to appear. The top 20 VCs are in Silicon Valley, because that’s where the unicorns are. The unicorns are there because the UEs, which start unicorns, are there. VCs don’t do much before Aha – they don’t start unicorns. They come in after Aha, ie after potential is apparent. To build unicorns elsewhere, ESG VCs need to develop unicorns. To do this, they must train all entrepreneurs to bridge the VC gaps with unicorn strategies.
#2. Expand VC availability from family tree to skills. Don’t turn anyone down – they could be the next Steve Jobs. About 10 VCs turned down Steve Jobs, one of the greatest entrepreneurs of all time. Offer training, not capital. No one can identify unicorn potential by looking into an entrepreneur’s eyes or listening to a pitch. ESG-VC can train anyone to build a unicorn with the skills and strategies used by the 94% of unicorn entrepreneurs who started out without VC.
#3. Design better exits. VCs need to exit their ventures quickly due to the 10-year lifespan of the typical VC fund. To exit at high valuations, VCs need strategic selling or an exuberant stock market. Not many qualify for IPOs, especially when the stock market isn’t in a foam. In a strategic sale, the return may be lower and the acquiring company may relocate the company. ESG-VC needs more equitable exits, especially for low-income areas.
#4. Using smarter financial instruments. Go back to the future for more just exits. VC started with subordinated convertible loans with detachable warrants that offered liquidity and yield. This instrument can be adapted to better compete with the preferred financial instrument used by institutional VCs in the 21st century.
#5. Make highly profitable ESG VC less dependent on home runs. By combining UE and a smart financial instrument, ESG-VC can build more unicorns while relying less on unicorns for their exits. This can open ESG-VC to anyone who proves their skills.
MY TAKE: Entrepreneurs can build unicorns with ESG (the real kind rather than the tortured definition used by financial institutions), in all communities by using unicorn skills and strategies. 18% of EUs postponed VC and 76% avoided it. By helping entrepreneurs make a start without VC, ESG-VC can start more unicorns, fund them and deliver on the ‘S’ and ‘G’ goals of ESG. That would be a good start.
