Running a business requires getting investors on board to help with funding. It’s not always an easy task, even when you have a strong business model and have already seen some success. Most investors are selective about how they invest their money, especially since so many startups fail, despite seeming like they’ll be the next big thing in tech.
Although investors are looking for signs of viability and profitability, they’re also looking for signs of environmental responsibility. Many investors aren’t willing to support an organization unless they’re actively making the effort to align with eco-friendly practices, especially as ESG-related regulations tighten.
Before investing, they look at environmental, social, and governance (ESG) factors to see how the company measures up to regulatory standards.
If you’re not familiar with ESG reporting, and you’re seeking investment capital, it’s important to understand why investors care and what they’re looking for. To help you understand better, in a thorough and in-depth guide, Workiva answers the question, what is ESG?
What is ESG reporting?
ESG reporting is broken down into three parts: environmental, social, and governance.
Environmental reporting covers a company’s environmental responsibilities, like:
- Greenhouse gas emissions (like carbon)
- Consumption of energy
- Impact on climate change
- Pollution
- Waste disposal
- Depletion of resources
- Renewable energy
Social reporting covers a company’s social responsibilities, like:
- Discrimination
- Diversity
- Human rights
- Community relations
Governance reporting covers how a company is directed, controlled, and held accountable, like:
- Executive compensation
- Shareholder rights
- Board elections
- Political contributions
- Takeover defense
- Staggered boards
- Open configuration options
- Independent directors
Why do investors care about ESG?
The general consensus is that investors view ESG-compliant companies as less risky and better positioned for long-term success. Now more than ever, it’s important for businesses to embrace the old way of being where stakeholder opinions matter most.
It’s becoming harder to do business with companies that don’t factor environmental impact into how they operate because it’s no longer socially acceptable. This applies to billion-dollar investment firms and individual investors alike. People want to put their money into sustainable businesses.
Harvard Business Review interviewed 70 senior executives at 43 investing firms, which included BlackRock, Vanguard, and State Street, among others. Most large investment companies have 25% of their shares being held by companies that prioritize sustainability.
The bottom line is that companies that adopt ESG reporting requirements are more likely to get funded and sell stock. Organizations that avoid meeting sustainability standards often don’t get funded at all. In fact, studies have shown that ESG investments are more profitable, so it’s not just a perception.
ESG-aware companies are seen as a threat
Since companies that adopt ESG reporting standards are getting most of the money, it’s causing some people to attempt to boycott those institutions. There is significant pressure on non-ESG-aware companies and it’s putting some of them out of business.
The issue is much more heated than you might think. In 2021, Texas Governor Greg Abbott signed legislation barring municipalities from working with banks that only fund fossil fuel or firearms companies. This caused five major bond underwriters to exit, costing the state more than $300 million.
When legislation pulls money away from organizations that don’t meet sustainability requirements, you know it’s only a matter of time before every business owner realizes they can’t afford not to follow ESG requirements.
Companies that care about ESG do better
It’s not possible for any organization to address every possible environmental, social, and governance issue without watching their financial performance tank. However, organizations that focus on the most important issues will be more likely to outperform those that ignore ESG all together.
When companies focus on material issues most related to their industry, they generally get higher financial returns. Having great ratings for ESG compliance issues does help businesses outperform those with poor ratings.
Investors specifically look for ESG compliance
Most of today’s investors are intentionally looking for evidence that companies they hold stock in are focused on, and have prioritized the various material ESG issues that impact financial performance. This is the only way to know what’s actually going on with the company.
Many businesses have gotten caught up in what’s called “greenwashing,” and make sustainability claims that just aren’t true. Having standards to verify and reports to look through is the only way to separate authentic from the inauthentic sustainability claims.
Since there’s a lot at stake financially, it might be time for businesses to return to aligning with stakeholder values, including ESG responsibilities, to avoid failure over a lack of funds. Or worse, being boycotted for not being on board with sustainability.
