Selecting the right solution can be daunting
With the recent implementation of the EU Sustainable Finance Disclosure Regulation (SFDR) and increasing pressure from Limited Partners/investors (LPs), venture capital (VC) and private equity (PE) firms are required to be transparent about how they consider sustainability factors in their investment decision-making. To address this, sustainability management software solutions are designed to help portfolio managers comply with regulatory requirements and manage sustainability to their advantage.
However, selecting the right solution is a daunting task due to the many options and offerings currently available. Beyond the obvious software selection criteria such as cost or data security, sustainability-specific considerations are crucial to evaluating the alternatives.
Following are five not-so-obvious selection criteria that are paramount in finding the right sustainability management software for a venture capital or private equity firm:
To start, one criterion is the degree of how well the software actually performs on the sustainability management aspect. For that, let’s acknowledge the difference between “reporting tools” that focus on the pure compliance aspect, and “management solutions” that support the fund manager in driving sustainability performance of the companies in the portfolio.
A good analogy would be that a reporting tool is similar to a tax return preparation tool that is used once a year, while a sustainability management software is similar to a trusted business advisor that guides the company on an ongoing basis.
The question should be: Does the software support the administration, execution and supervision of the environmental, social, and governance (ESG) or Impact policy of the fund over time? Reporting tools cannot do management, but sustainability management software typically integrates the reporting for compliance purposes.
Any good software today should be easy to understand and use, to be “intuitive”, so to speak, which are the obvious criteria. Being able to educate and enable the user is the not-so-obvious criterion. Sustainability is a complex topic, in itself a hurdle for stakeholders to wrap their heads around, let alone activate projects. Especially, VCs and PEs that invest in startups and small & medium enterprises (SMEs) should take into account the limited expertise and resources of their investees.
Delivering educational guidance in a way that encourages the user to learn key principles and apply them sets the bar for high-quality sustainability management software. Translating complex topics into actionable guidance allows portfolio managers and portfolio companies to focus their resources on improving performance.
In the selection of sustainability management software, it is crucial to consider the sustainability expertise of the team behind the software. With the pressing issues of climate change and resource depletion, taking immediate action is imperative and increasingly demanded by regulators and LPs. Fund managers will need to consider the risk if they only rely on a pretty tool that collects KPIs. It is increasingly about taking action instead of pure compliance.
The software should also be able to differentiate between ESG and Impact. ESG primarily focuses on identifying potential negative aspects in the near term, while Impact assesses the positive and negative impact of an investment on society and the environment in the long term. In this complex space, the software needs to guide funds and portfolio companies via thought-through modules to action. And, selecting a software provider with quality expertise can increase the trust of LPs and auditors towards a positive sustainability performance outcome.
4) Analytical Insights
It is obvious that software should be informed by key sustainability standards, which are mandatory regulation and voluntary guidelines of governments, standard setters and major investors/limited partners (LPs). With those standards come comprehensive sets of key performance indicators (KPIs) to measure and track the ESG and Impact performance of portfolio companies over time. Key industry standards are covered in the Appendix. Any software should offer sufficient customization of KPIs to capture the specific characteristics of the fund portfolio (company size, business model & industry, fund strategy, etc.).
The not-so-obvious criterion is to go beyond pure compliance and KPI tracking, and to the provision of actual insights about the sustainability performance of portfolio companies along the requirements of these standards. This starts with KPI-benchmarks between companies, but it goes deeper. Good software should help to analyze the maturity of the sustainability management at each portfolio company and point out material risks and opportunities. This sustainability intelligence can save fund managers and portfolio companies a lot of time and reduce the need for costly sustainability consultants that often have to step in to help portfolio companies.
This is the most fundamental criterion. After all, true sustainability management is not about checking boxes for compliance, but about minimizing negative effects of the business at hand, mitigating risks and increasing the actual sustainability performance of the portfolio towards a positive, long-lasting impact. That is a collaborative effort of the portfolio manager together with all company stakeholders towards continuous improvement.
So good management software should be able to…
a) Plan, e.g. by providing education, best practices, benchmarks and decision support and by recommending specific measures tailored to specific company use cases
b) Do, e.g., by empowering stakeholders through task management and in-depth information on how to implement measures;
c) Monitor, e.g., by tracking progress, highlighting shortfalls, and facilitating stakeholder engagement and communication; and, finally
d) Optimize, e.g., by recommending further improvements based on the project results.
In summary, the below criteria for selecting sustainability management software should enable VC & PE fund managers to find the software solution that matches the funds’ sustainability approach. Increasingly, LPs and regulators expect quality in performance on all aspects of the business. So aiming for high quality sustainability management is a business decision that will ultimately pay off – it is not a philanthropic act. Continuous improvement should be the underlying modus operandi for sustainability.
The EU taxonomy is a classification system, establishing a list of environmentally sustainable economic activities. It could play an important role helping the EU scale up sustainable investment and implement the European green deal. The EU taxonomy would provide companies, investors and policymakers with appropriate definitions for which economic activities can be considered environmentally sustainable. In this way, it should create security for investors, protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed.
In 2022, Impact Frontiers incorporated the resources developed by the Impact Management Project (IMP), a non-profit forum for building global consensus on how to measure, manage and report impacts on sustainability.
IRIS+ is the generally accepted system for impact investors to measure, manage, and optimize their impact.
Credible, comparable impact data are needed to inform impact investment decisions and drive greater impact results. IRIS+ solves for this by increasing data clarity and comparability, and it provides streamlined, practical, how-to guidance that impact investors need, all in one easy-to-navigate system. It is a free, publicly available resource that is managed by the Global Impact Investing Network (GIIN) – the global champion of impact investing.
The Sustainable Finance Disclosure Regulation (SFDR) is a European regulation introduced to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.
For more information, see our blog – what investors need to know about SFDR.
The PRI (Principles for Responsible Investment) is the world’s leading proponent of responsible investment. It works:
- to understand the investment implications of environmental, social and governance (ESG) factors;
- to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions.
The PRI is truly independent. It encourages investors to use responsible investment to enhance returns and better manage risks, but does not operate for its own profit; it engages with global policymakers but is not associated with any government; it is supported by, but not part of, the United Nations.
The six Principles for Responsible Investment offer a menu of possible actions for incorporating ESG issues into investment practice.
- Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
- Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
- Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
- Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
- Principle 6: We will each report on our activities and progress towards implementing the Principles.
The Sustainable Development Goals (SDGs) are a collection of 17 interlinked objectives designed to serve as a “shared blueprint for peace and prosperity for people and the planet now and into the future”.
The SDGs are: no poverty; zero hunger; good health and well-being; quality education; gender equality; clean water and sanitation; affordable and clean energy; decent work and economic growth; industry, innovation and infrastructure; reduced inequalities; sustainable cities and communities; responsible consumption and production; climate action; life below water; life on land; peace, justice, and strong institutions; and partnerships for the goals.