Startups Need an ESG Strategy

Startups are often just trying to survive — do they have time to worry about ESG? Yes. That’s because they must be aware of the material risks and opportunities in their given industry, which is essentially what a careful ESG strategy provides. Startups should start by identifying their purpose, then marry that purpose to ESG considerations — for instance, by identifying risks to avoid and manage. Startups should be mindful of their carbon footprint, ensure they treat their employees well and have diverse boards to oversee them.

Over the last five years, the corporate world has focused increasingly on implementing stakeholder capitalism through Environmental, Social and Governance principles (ESG). However, is ESG a distraction to cash-strapped talent and time constrained startups? Should founders build their business first and worry about ESG later?

Quite the contrary: start-ups have an advantage over larger companies whose “installed base” of assets, products and culture often needs to be undone to be consistent with ESG principles. It is possible to build it from the beginning, saving costly rework later. They can also do it in a way that does not distract from the urgent search for product market fit.

Here is a novel approach for founders to launch their ESG journey.

Begin with the Purpose

Purpose crystallizes the unmet need a startup is answering and the unique strengths it brings to do that. Purpose answers: “What would the world lose if the startup disappeared?” Could competitors easily replace it or is there something unique it brings which customers will pay for, which is embedded deeply in its core strengths and value proposition? Purpose is a lot more than branding and PR. When employees feel their personal purpose can be lived at work, they are four times more likely to be engaged. It inspires stakeholders, helps the company focus its efforts, and make trade-offs in moments of truth. Startups often benefit from a strong sense of purpose given their proximity to a founder’s initial passion to solve a problem in the world.

ESG – Marry Purpose

ESG is different from Purpose. ESG frameworks suggest How You run your business to fulfill your purpose and implement your strategy. And What your exposure to specific risks is. It is a framework that guides business decision-making. ESG does not provide a framework for business decision-making. It’s not Anker In the business. On the other hand, ESG without purpose isn’t Focus enough on the few crucial topics underpinning the startup’s strategy. It’s just a laundry list. Purpose helps founders identify the few dimensions the startup chooses to “win” on versus just being a good citizen.

Identify material risks

Founders must identify the risks they need to manage and avoid. George Serafeim’s seminal 2015 research underlined that efforts should focus first on risks that are material to a startup’s specific sector/business. SASB and other frameworks are useful in identifying ESG risks. Start-ups should begin there and not try to boil the ocean. Failure can prove fatal. Data privacy is one example of a major risk in the EdTech industry. Dozens of startups risk losing important government contracts as a recent Human Rights Watch report on the EdTech sector exposed that many were selling personal data to advertisers that they had collected from minors using their education apps, falling foul of the most basic privacy expectations under the ‘G’ (Governance) bucket of ESG.

Whatever sector startups are in, our research suggests the following short list of material risks should be prioritized because they can have high financial impact when done wrong and because they have high overlap with “typical” startup priorities.

On E: Startups must set a goal on their carbon/natural resource footprint.

Only 7% startups have a net-zero plan. And yet it’s a top priority for investors who themselves are under the greatest regulatory pressure for transparency in this area. Investors can’t meet their climate targets unless the companies they invest in do. Startups can track basic resource usage through utility bills. As startups scale, it is possible to establish sustainability in their supply chains by having a net zero force early. This also protects against reputational risk from poor supply chain controls, avoiding what the startup darling Daily Harvest is facing today.

On S: Startups must build a strong social contract with employees; including ‘living’ wages, an inclusive culture, and support for mental health.

The war for talent in an environment of labor shortages is intensifying. Companies that pay a living wages have a 30% lower rate of attrition in the Great Resignation era. This is the most important ESG dimension for employees in the United States today. 40% of workers complain of burnout or other mental health issues. Inclusive cultures can counter this. Anyone who is a successful founder and has more than two employees promotes diversity and a sense of belonging. WeWork and Uber’s past challenges are salient reminders of the negative impact of toxic cultures.

G: Startups need diverse boards and solid data security rules.

Investors are becoming more sophisticated Investors will expect startups to have diverse boards. It’s the most publicly visible ESG metric investors can track, so is usually built into their early due diligence processes and included in their own targets. Furthermore, increased board diversity correlates highly with stronger business performance.

Startups should also ensure that they have solid privacy and data security rules. Most startups have lost customer trust by failing to protect their data. This has triggered increased regulatory scrutiny. Note the EdTech example above, and myNurse, a healthcare startup up shuttered in 2022 after a data breach affecting 1.7 million patients.

Companies which outperform on ESG tap into five sources of value: Lower risk, cost of capital, and regulatory intervention, and higher Retention, talent attraction and growth. Startups develop a competitive advantage from building Purpose and ESG into their DNA from the start.

Purpose helps inform ‘offense’ on a few chosen areas of distinctiveness. ESG helps inform “defense” in material categories. In all cases, startups must cover specific basics including climate targets on E, a strong social contract on S, and diverse governance and strong data processes on G. Optimally, the founder should clarify “who” is accountable for implementation, back priorities with metrics, and report progress to their board alongside other priorities.