Managing ESG within the venture capital industry

Lakestar has seen an increasing level of scrutiny on environmental, social and governance (ESG) themes within the venture capital (VC) industry. The introduction of the Sustainable Finance Disclosure Regulation (SFDR) requiring mandatory reporting, the continued conversations on climate risk and the push for greater diversity amongst the workforce are just some of the topics driving the conversation on responsible investment and ESG. We will share some of the challenges we are seeing along with the initiatives we are undertaking in response.
 

Increased visibility on ESG
It is not difficult to find an invitation to an ESG discussion; typically, these will focus on how important that topic is, the challenges of finding an owner for the topic within a firm and the intensified pressure from Limited Partners (LPs) but why has the topic become so prominent?

One factor can be the increased exposure climate risk has been subjected to. There was an unprecedented level of media attention on COP26. Alongside this, there continue to be protests against the companies who continue to finance non-renewable energy projects.

Finally, it can be argued that we are now seeing the consequences of years of global warming through changing landscapes and displacement of habitats. LPs, VC Firms, and society as a whole recognise even more so that investment decisions have an impact.

But this is not the only thing grabbing their attention. Over the last 18 months, the impact of the pandemic, cases of social inequality and the exposing of ‘greenwashing’ campaigns have got us asking even further questions. There is greater focus on the supply chain of not only the VC Firm but also the portfolio companies and along with this, gender and racial diversity continues to be under enhanced scrutiny.

Questions that VCs are being asked
As a result, there is a greater desire to see a commitment from VC firms on ESG. Fundraising continues to be extremely competitive amongst both potential and existing investors. Since 2019, the questions Lakestar has faced evolved from simple ‘yes or no’ to detailed quantitative-driven responses required.

ESG performance and metrics now has the potential to increase or decrease the prospects of follow-up funding and indeed in the past 12 months alone, we have seen a greater demand on metrics and KPIs. The introduction of regulation such as the Sustainable Finance Disclosure Regulation (SFDR) and initiatives from the Taskforce on Climate Related Financial Disclosures (TFCD) emphasises the need to be able to have data on the portfolio readily available.

There is no single ‘Golden Framework’ that can be relied on by all parties, but we are starting to see that our LPs expect there to be a certain baseline of information readily available to them. Within this data, it should be able to demonstrate how ESG scoring has impacted/categorised potential and completed investments and how that data is then used by management as part of the decision-making process or ongoing management.
 

What has Lakestar been doing?
As part of responding to this challenge, Lakestar has worked with other members of the ESG VC Steering Group to design a framework that aims to benchmark companies on their performance and can be tailored from seed to growth across a range of B2B and B2C sectors.

We believe that we have a duty to the ongoing development of our companies and whilst this data will assist us in reporting at a company and at a fund level, what it also allows us to do is tailor resources and guidance to our companies to help them strengthen any areas following the completion of the questionnaire.

Furthermore, we have introduced a sustainability clause following work with Leaders for Climate Action (LCFA) focusing on sustainability within our term sheets ensuring commitment to achieving goals from our portfolio companies within specified time frames. As a result of working with LFCA, we also continue to track and offset our carbon emissions (2x) with the help of Climate Partner.

Lakestar also sits on the VC Frameworks Steering Group at Invest Europe, the association representing 1,600 of Europe’s PE, VC and Infrastructure Sectors and our founder, Klaus Hommels, is the Chairman for the 2022–2023 Session. We are in the process of creating a guide on how to tackle the challenge of ESG and create a template which will serve as the starting point for newcomers in the industry. As part of our membership with Invest Europe, we have spoken with the Canadian Venture Capital Association on best practices and areas of challenge and continue to expect similar engagements.

Lakestar is also a member of Venture ESG and part of its Framework and Metrics Working Group. Venture ESG is a community of funds committed to integrating ESG practices into their end-to-end processes. Their primary aim is to help the VC sector recognise the importance of ESG and to provide resources to make this topic standard part of diligence, portfolio management and fund management. Venture ESG maintain a comprehensive list of resources for VCs and Portfolio Companies to use to improve their overall ESG framework.

As well as this, Lakestar is a member of the UN PRI VC Working Group. The UN PRI is the world’s leading proponent of responsible investment. It works to understand the investment implications of environmental, social and governance (ESG) factors and to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions. The Working Group is focused on improving the accessibility of the Signatory Program to the VC community.

Finally, Lakestar has received Level 1 certification from Diversity.VC, the leading D&I certification standard in the community. Diversity.VC has created a standard for VCs to achieve which focuses on representation in the workplace and across the portfolio.

Looking inward
At Lakestar we also realise that ESG is not purely about what initiatives you are aligned to and where you have become a signatory. Internally we continue to embed best practice on the topic. Our team continue to ensure that our employee benefits remain at the top end of market standards. We continue to work with under-represented founders and continue to deliver guest lectures not only internally but also at several educational and professional institutions. In the past few months, we have stepped up to help those affected in Ukraine by sponsoring and filling supply trucks to the region and helping those displaced with finding new job opportunities.

In the past 12 months, Lakestar has continued to strengthen its governance with the hiring of a compliance officer, the continued effort on having KPI and data available for senior leadership as well as having a strong set of policies, procedures and training programmes in place.

As mentioned, ESG is here to stay it is not a tick box exercise. We cannot be complacent about how we approach this – there isn’t one body or organisation responsible for ESG matters – but Lakestar has put itself at the front of decision making and continues to make decisions with ESG always in focus.