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In a relatively short time, environmental, social and governance (ESG) issues have catapulted from the sidelines to center stage of the corporate agenda. Yet many organizations, private equity firms included, grapple with how to execute on the ESG imperative. Private equity (PE) firms often struggle to balance what can easily be perceived as conflicting goals: generating a return for investors while meeting the broader ESG goals of their stakeholders.
As a result of these evolving issues, PE firms are becoming more selective of their targets: 37% of respondents in our Global PE Responsible Investment Survey have turned down an investment opportunity because of ESG concerns.
In our view, companies that are good ESG citizens have the potential to earn a premium, not just in goodwill and enhanced brand, but literally. Today, any portco that can provide investors and other stakeholders the assurance that they are adequately addressing ESG issues has an opportunity to create value. We’ve previously written about what we’re seeing in the private equity space more generally when it comes to ESG. Here we delve into more detail on what PE firms’ boards should do as they focus on the primary concerns within each portfolio company’s industry in order to create value.
ESG priorities differ by company, depending on industry. In some industries, the impacts of ESG issues are direct and well known: regulation has meant that there is a long history of tracking them, with more metrics available. Other issues may be less quantified, either because they’ve emerged more recently and appropriate metrics haven’t yet been standardized or implemented, or because the impacts are indirect or intangible, and are therefore harder to quantify.
Climate change is the predominant environmental concern, imbued with increasing urgency as more nations and companies worldwide commit to net-zero carbon targets. In our global survey of PE firms, half of all respondents say they are taking action on climate risk and nearly half (48%) report taking action on the carbon footprint of their portfolio companies.
Within every industry—and even from company to company—the ESG journey will differ. Every PE fund should develop plans for the near, medium and long term, and address issues for the collection of its portcos, as well as each one individually.
To start, we recommend that funds gather data and conduct a diagnostic on their entire portfolio. For portcos in industries that haven’t yet standardized metrics or benchmarks, it will take additional effort to determine the appropriate steps.
Much of the data needed to provide a reliable performance picture may not be in an easily accessible form. Moreover, getting consistent data across the portfolio may be challenging. Some PE pioneers are finding creative ways: One uses the same payroll processing company for all its portcos. The payroll processor holds relevant data on employees that can inform D&I goals. Some companies have even turned to their cloud service providers to help them gather and analyze the data they need to make their ESG goals happen. In our Cloud Business Survey, we found that 70% of respondents are either implementing or actively looking into how cloud can support their ESG goals.
Once you have the data you need, create an ESG diagnostic that will show how each of your portfolio companies is handling its ESG risks. We recommend that you tailor the diagnostic to those ESG issues that are market priorities in each industry, such as waste management for emitters or safety and injury prevention for manufacturers. Developing an accurate diagnostic will take time, but a diagnostic has the potential to be a cornerstone for how you assess the ESG performance and tracking at your portcos.
When you are thinking about which companies to prioritize first, we recommend that funds:
Build a business case for ESG investment. Demonstrating knowledge of the market’s perspective on ESG and of the changes that can produce the greater return will go a long way toward winning executive buy-in on ESG goals. Let’s look again at manufacturing: Showing that a small change in manufacturing practices can deliver substantial benefits to ESG ratings will help make your case for your ESG ambitions.
Rally the CEOs of your portcos. PE firms face a unique challenge in that funds have a vested interest in the performance and strategy of the underlying portcos, but the portcos themselves need to execute on the strategy. As a result, it’s critical to align the operating models of the portcos and get CEOs on the same page as the PE firm.
Given the number and scope of ESG issues, developing sound and credible policies can be tricky for PE funds and their companies. Our framework offers a good start, helping you make smart, objective decisions based on consistent and credible data, while taking into account the nuances of each industry. By focusing on the major issues in each industry and fostering a unified approach among portco executives, PE funds can do more than demonstrate good citizenship: they can keep their eyes on the value-creation prize.
Rapid Value Delivery Leader, Chicago, IL, PwC US
Eric Janson
Partner, Private Equity, PwC US
Aaron Gilcreast
ESG Deals Leader and Global Valuation Leader, PwC US
Ryan Folscroft
US Asset and Wealth Management Sustainability Partner, PwC US
Abigail Paris
Director, PwC US