Responsible Investment in Venture Capital: 3 Strategies to Advance ESG

Venture capital firms have historically been the first investors in many of the world’s largest and most influential companies. In the last few years, the world’s largest tech companies have run into major challenges in managing growing societal issues — the result being that governments, media and activists have dug deeper into their foundational values and cultures. Here, our expert contributor explores some of the challenges venture capital fund general partners, limited partners and founders face in managing ESG issues and suggests a strategic roadmap for the industry along 3 pillars.

First Investors and Board Members Play an Important Role Shaping the Early Years of Tech Company’s Business Models and Cultures

Venture capital funds have been the first investors in many of the world’s largest and most influential companies including Google, Facebook, Twitter, Uber, Airbnb and many others. The business model, culture, and values of global companies are often shaped in the early years of a company’s development, and venture capital firms as the first investors and board members play an important role in this process. In the last few years, the world’s largest tech companies have run into major challenges in managing societal issues ranging from living wage, privacy, and protecting human rights and democracy—the result of which has been governments, media, and activists taking a much deeper look how foundational values and cultures were shaped.

In 2018, more than 70% of institutional investors integrated ESG (environment, social, governance) considerations into the selection and management of their investments. ESG practices now span major asset classes from public companies, private equity, real estate, bonds, and commodities. Yet venture capital has lagged behind other asset classes, with no systematic approach to screening, managing or reporting ESG performance.

Role of Investors Building A Next Generation of Commercially Viable Tech Companies Working for the Benefits of the Many – Not Just the Few

A new discussion paper published by Harvard Kennedy School’s Belfer Center for Science and International Affairs  Responsible Investing in Tech and Venture Capital explores some of the challenges venture capital fund general partners (GPs), limited partners (LPs), and founders face in managing ESG issues and proposes a road map of strategies the industry could take along three pillars.

1.     Technology and Risk Management

Venture capital is among the highest risk forms of investment. Yet the industry has no systematic approach to societal risk management. Among the most common types of risks investors in ventures face are uncertainty regarding readiness and performance of new technologies, stakeholder concerns such as achieving a product-market fit, managing regulatory uncertainty,  and developing fair terms for customers, suppliers and business partners,  and governance concerns such as establishing board oversight.   New tools specific to early stage companies and emerging technologies could be built to support entrepreneurs and fund managers in surfacing and addressing risks and societal impacts earlier in the company’s development.

2.     Data and Transparency

Data is critical to investment decision-making and management. Investors already have ESG data on public companies from multiple independent ratings agencies. Data is currently available on financial and market performance of venture capital firms and portfolio companies in industry databases such as Pitchbook and Crunchbase. However, there remains no independent assessment or reporting database for ESG risk and performance in ventures. ESG data on ventures can contribute to building an evidence base of which factors lead to better financial outcomes.  For GPs, ESG data can help in the sourcing, due diligence, and management practices by giving comparable information on best practices within an industry. For LPs, ESG data can aid in the decision to select fund managers in line with their ESG commitments and provide a mechanism to monitor reputational risks.

3.     Diversity and Culture

Venture capital firms and founders receiving funding have high levels of underrepresentation of women and people of color. A 2016 survey by the National Venture Capital Association and Deloitte of the U.S. venture capital industry found that 80% of partners are white and 86% are male. A 2018 study by Pitchbook found only 20% of venture capital funding went to start-ups with at least one woman on the founder team.  The industry has already created several initiatives aimed at improving diversity in fund leadership and founder teams. Some examples include All Raise, a non-profit advocating to advance women in venture capital and raise representation of female partners to 25% in the next five years. Founders for Change tracks diversity inside venture capital firms and collects pledges from VCs to commit to more diverse hiring and investment. Other actions to advance diversity could include LPs monitoring and reporting diversity and tools to support founders in creating more ethical and inclusive cultures.  

Click here to access the full report.

Conclusion: a Next Generation of Tech Companies is Coming and Investors Have a Role Advancing Public Purpose

Advancing public purpose in venture capital will likely require the activation of the different strategies outlined in the attached research paper. The dominant global tech players today were indeed founded 10 to 25 years ago.

Now, 3D printing, nanomaterials, AI and robotics, biotechnologies, blockchain and distributed ledger, neurotechnologies, VR/AR, quantum computing… are just some of the many technologies likely to reach the global market and shape our societies and daily lives for the years to come.

Learning from recent decades would encourage emerging players to closely consider the findings outlined in this report. Actively engaging boards and heads of emerging tech companies will surely be instrumental in managing risks and proactively addressing the nexus of sensitive ethical, social or environmental challenges and opportunities brought to bear by the new digital age. Think cybersecurity and elections, blockchain and tax evasion, biotechnology and the expression of unknown proteins/enzymes, AI in cars and the related ethical dilemma. Similarly, linking sensors and civil surveillance, quantum computing and new/unforeseen behaviors in computing systems, automatization and job destruction are but some of the challenges ahead…

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