How do investors/VCs value ESG principles when investing in startups?
True innovation in a post-pandemic world begins with entrepreneurship. With the upcoming Industrial Revolution 4.0 and an integrated economy, the societal, environmental implications on the climate have been steadily increasing. It is crucial to consider sustainable alternatives to avoid harsher implications in the long run. Investors are now using tools to measure the environmental, social, and corporate governance (ESG) impact on a startup’s business model. In a 500 startups survey, 62% of founders surveyed had ESG policies in place, of which 43% shared that it had improved their fundraising efforts (Glover, 2021).
Truly a hotbed for innovation, the Southeast Asia (SEA) region has a vibrant startup scene with big markets such as Singapore, Indonesia, and Vietnam. Yet in a fragmented regional economy, it is essential for startups to leverage each country’s strength when expanding. Investors are drawn to the potential growth within this region and place greater emphasis on startups involving sustainability in their pitch deck (Yeo, 2020).
This article seeks to examine how the principles of ESG are present in the startup ecosystem in Singapore and its neighboring countries.
What is ESG Investing?
Simply put, ESG investing involves implementing key metrics to measure a company’s risks external to their financial accounting risks. The Environmental, Social & Governance (ESG) framework incentivizes investors to closely examine the crucial risks that could potentially lead to harsher implications for a company if it’s unable to sustain itself properly. These risks fall under a wide spectrum from climate change impacts, working and safety conditions, to complying with relevant laws and regulations. The E, S, and G factors are usually intertwined and one quick decision disregarding E, S, or G can lead to the domino effect of others. For instance, poor governance on a new workplace policy (G) could lead to worker strikes (S), which could lead to interruptions in safety protocols and ultimately environmental disasters (E). Thus every decision a firm makes can lead to consequences that could be avoidable if these decisions were examined clearly (Lomax, 2020). Startups are no different. Though small in size, the bulk of decision-making is handled by the founding team of a startup.
A case can be made that it is much easier to start a company with proper ESG metrics than to reconstruct a larger company. An example would be incorporating diversity into the company profile (S & G). If the founders were to start out with a diverse group, then the founding group would be able to account for multiple perspectives than a homogenous group. It will also make the team more appealing to VC firms targeting companies with diverse profiles. In such a scenario, it is less challenging for a startup to accommodate ESG principles as compared to a larger company where long-term plans and risks are present in reshuffling manpower to improve their diversity profiles.
On the other hand, early-stage startup founders typically do not have the time or resources to dedicate their focus to ESG and are primarily focused on reaching a product-market fit. The parameters of ESG investing in the context of technology startups are not clearly defined. This creates a gap in understanding between the investor and founder on the firm’s social responsibility. A possible course of action could be for founders to become well-versed with ESG metrics and find avenues to adopt these metrics at the start, during the ideation process.
Startup Ecosystem in Southeast Asia
Accounting for 8.6% of the world’s population, the SEA region has been gaining traction and attracting international investors and venture capitalists. According to a study by Kroll, over 25% of investments in SEA are from the United States (Khurana et. al, 2018). There are over 300 deals with over US$5.2 billion invested in this region with increasing foreign investors committed to ESG.
The rise of the SEA ecosystem primarily stems from the driven and talented workforce, government support, and active participation from the local community. Despite the strong work ethic of this region, SEA faces issues with the lack of experienced founders (Yeo, 2020). Many founders are starting a business for the first time and have not gone through the journey of market validation, achieving a product-market fit, developing a minimum viable product and then scaling that product. While this hurdle isn’t unconquerable, startup founders may need to anticipate a few obstacles along their journey.
Nick Nash from Asia Partner quotes “South East Asia is entering the Unicorn zone” where we are expecting to see exponential growth in GDP per capita in the next few years for this region. So with such a promising future, how are VCs and investors validating startups in this region?
A Promising Future for ESG Startups
In Singapore, investors are eying startups focused on ESG. Investments in sustainable and environmentally-friendly solutions increased by 56% in 2020 (Punay, 2020). A startup that effectively incorporates sustainability is SEPPURE which offers chemical separation processes that can be done without heat and can potentially conserve billions of gallons of water in a year. Even though deep tech is still at the helm, it is encouraging to see a growing number of investments in ESG startups from US$9M in 2019 to US$156M in 2020 (Punay, 2020).
Even as other countries within SEA churns out their own startups, an increasing number of Singaporean founders are looking to neighboring countries as a launchpad to test their business model. Through government initiatives, incubators, and accelerators, Singaporean founders are able to leverage the sheer market size of countries like Indonesia and Vietnam when expanding.
With an increasing growth rate in this region, startup founders are realizing that a growing number of investors are turning their heads towards ESG principles being applied. Countries in SEA can benefit from their geographical region and strive to incorporate ESG metrics to attract more funding. It is a win-win scenario and can propel higher growth within this region in the near future.
Glover, C. (2021, April 20). What does ESG mean for tech start-ups? Tech Monitor. Retrieved December 2, 2021, from https://techmonitor.ai/leadership/sustainability/esg-start-ups.
Khurana, R., Ozturk, C., Bhatia, T., Kageyama, T., & Ho, V. (2018). Spotlight asia report 2018. Duff & Phelps. Retrieved December 2, 2021, from https://www.kroll.com/en/insights/publications/apac/spotlight-asia-report-2018.
Lomax, A. (2021, November 24). ESG investing: Your guide to socially responsible stocks. The Motley Fool. Retrieved December 2, 2021, from https://www.fool.com/investing/stock-market/types-of-stocks/esg-investing/.
Punay, N. (2020). VCS bet big on ESG Startups. Singapore Business Review. Retrieved December 2, 2021, from https://sbr.com.sg/economy/in-focus/vcs-bet-big-esg-startups.
Yeo, S. (2020, September 30). Report: A glimpse into Southeast Asia’s impending golden age. Tech in Asia - connecting Asia's startup ecosystem. Retrieved December 2, 2021, from https://www.techinasia.com/report-glimpse-southeast-asias-impending-golden-age.