A relatively recent term that is commonly used in investing and venture capital spaces is ESG, or environmental, social, and governance. Similar terms that are used are sustainable or impact investing. These terms attempt to concretize the new all-encompassing idea of ESG. ESG is a broad term that can be easily used to discuss the general importance and impact that those three factors can have on a company. One example of an environmental change would be if a company decided to become carbon neutral, or even carbon negative. Some social changes might be having equal pay for men and women or social diversity programs to promote racial equality. Finally, governance refers to the idea that companies need to be run according to the proper regulatory standards and with the proper HR staff. For many startups, VCs are instrumental in providing them with the proper governance framework. This is because many startups are started by scrappy entrepreneurs that are not all that concerned with having the proper HR set up. This is one value add of VCs, in that they guide the company into using the best practices and setting up the proper governance structure.
One challenge that has arisen nowadays with all of the focus on ESG is how to effectively measure it. There are many intangibles when talking about ESG, and much disagreement about what should be considered a factor when trying to calculate ESG. Since ESG is a relatively new phenomenon, the framework for measuring it is developing at a rapid pace in order to meet the rising demand of investors to be able to properly assess companies using ESG standards. For example, Refinitiv is a company attempting to do exactly that; Refinitiv provides a score of each company they evaluated based on their methodology and the specific factors they include in their measurement of ESG. Some companies are hesitant to provide information about their products or practices, making it even more difficult to calculate ESG related metrics. Refinitiv uses the transparency of companies as a factor when giving a company its ESG score. The amount of information a company is willing to disclose about its practices impacts the score Refintiv will give them.
The new focus on ESG has led to another effect called greenwashing, which is where companies only pretend to make real ESG driven change. Some examples of greenwashing would be rebranding, distracting consumers, or making claims that cannot be proven without making any underlying change to their product or company. As ESG becomes more of a focus for investors, many companies have engaged in greenwashing to try to boost their ESG status. With the increased relevance of ESG, the ability to measure and define what it is should improve with time.