Raising capital and fund establishment

A fundamental consideration to determine at the formation/incorporation stage is to see what role ESG will have in the strategy of your firm, encompassing both the operational and the investment approach to ESG. Such a decision will be based inter alia on the level of motivation of your firm, the demand of your LPs, the standard of your peers, and the regulatory environment your firm operates in. Importantly, there should be consistency between your corporate and investment strategies. It would be inauthentic to focus on ESG in investments but not to reflect that in internal operating policies and procedures.

The materiality of ESG factors for the investments being made is also an important consideration to make ahead of time.

The decision will determine whether ESG factors will play only a basic role, a progressive role, or an advanced role. The eventual ESG policy will impact:

• which internal policies are developed;

• the ESG narrative that is chosen;

• which LPs are targeted for fundraising;

• what ESG resources and technologies are utilised;

• which portfolio companies are bought;

• what feedback is given and implemented; and

• how much ESG premium is targeted at exit.

All these considerations will mean very different things to firms that observe ESG at a basic level compared to firms that are advanced achievers of ESG.

When going into a fundraise, there are a number of elements which will determine what information you can/will share in the process as a fund manager. These include the geography and sector that your firm operates in, information provided to investors by your peers, and information demanded by your LPs.

Firms that are at the lower end of the spectrum will be sharing basic information about their ESG policies and how ESG impacts their due diligence, etc. More advanced firms will be sharing more tangible targets regarding their ESG ambitions and also showing from their previous track record how they have achieved them in the past. A firm that is newly raising or just starting on its ESG journey will generally need a longer preparation time to put in place the right policies and processes, if it wants to benchmark itself off a firm that has had a previous track record and has had multiple successful exits.

The regulatory environment that your firm operates in also impacts the nature of the ESG requirements in its structure and what information you will share with your LPs.

Firms in scope of regulations such as the EU Sustainable Finance Disclosure Regulation (SFDR), will be sharing information with their LPs based on the type of funds they market. A fundamental consideration to keep in context, is to determine what operational demands a regulation will create for your firm over its life cycle and ensure that they are properly anticipated in the beginning. Firms committing to higher level of ESG disclosures as in Articles 8 and 9 of SFDR, need to anticipate whether their future portfolio companies will be able to provide the relevant information or not. If not, then to avoid greenwashing, only those levels of disclosures should be committed to that are operationally possible. Please see the regulatory mapping section of this guide for more information on SFDR.

The right industry accreditations can help a firm progress on its ESG journey. Factors to take into consideration when choosing the right partnership could include:

• the overall aim of the body and how the accreditation will help your firm;

• the body’s market acceptance and following by your firm’s peers;

• the initial and ongoing reporting requirements; and

• the ongoing help provided by the body in the process.

You should spend adequate time on taking this decision, otherwise future compliance demands could create operational costs that could outweigh the benefits.

Based on the prominence given to ESG by your firm, finding investors that share this focus will be key.

A mismatch could mean differing ESG demands by different investors, which would create excess operational burden on your firm. On the other hand, the likeminded investors will be able to support your firm with the key timescales and partnerships in the months and years to come, and your firm will be able to target the ESG premium that an asset, that performs well in understanding its ESG risks and opportunities, commands. You should communicate the right level of information to your investors, highlighting:

• the ESG policies and procedures, including the specific governance policies of your firm;

• the type of investments intended and undertaken in the past;

• the ESG targets in terms of cost savings as well as value addition and impact; and

• the ESG achievements to date based on exits of previous investments.

It is important to bear in mind that LPs may have different ESG assessment frameworks, which will not all put the same level of emphasis on the same ESG areas. For example, some LPs will pay a lot of attention to governance and from the get-go firms advocating a focus on sustainability should be able to prove that their governance processes have adequately considered ESG. Some LPs will also evaluate the management of climate change risks separately to other ESG risks, while other LPs might also assess other systemic risks such as Diversity, Equity, and Inclusion (DEI) or social inequality (employee ownership as the new ESG trend started recently). As a fund manager, you may want to consider this when you are setting up your ESG processes. The ILPA ESG Assessment Framework, which covers different levels of sophistication on what good ESG looks like, may give a good indication of which areas LPs may be focusing on.