How to Incentivize Sustainability in Private Equity

When it comes to sustainability reporting and disclosure, most investor engagement focuses on S&P 500 - large, publicly-traded companies. Yet this leaves out thousands of privately held firms that make up a large part of our economy. According to the Private Equity Growth Capital Council, in 2012 over 2,600 firms were privately held with $313 billion of invested equity, accounting for 8.1 million employees. Some of these privately held firms are large companies and well-known household brands like Dunkin’ Donuts and Petco, and many have a substantial impact on our environment and society – but are not necessarily held to the same standards as publicly-traded companies.

The Environmental Defense Fund (EDF)’s Green Returns program engages with private equity firms and portfolio companies to identify opportunities to reduce environmental impacts. The program started back in 2008 and boasts 38 participating firms through three private equity partners.

A prime target?

From a publicly-traded company's perspective, the incentive to engage in a sustainability reporting effort is fairly well understood: investor pressure, public pressure, risk management, cost savings and, of course (?), doing the right thing. The same drivers don't necessarily apply to privately held firms: most firms are not under such close scrutiny from their customers, the media, or the public at large. For companies focused on growth and proving their worth in a short time frame, there can be a temptation to push back doing the right thing to later, when the company is more established.

In many ways, private equity presents a natural opportunity for environmental and ESG activists. Private investors are focused on the longer-term, looking a building a company's value over five to seven years, rather than focused on quarterly results like most investors in equity markets. Private equity firms also wield a lot of power in their portfolio companies, and can play a key role in convincing the board to engage into sustainability efforts without having to convince thousands of other investors. And engaging with private equity gives leverage to drive change in several companies at once.

Why should private equity investors care about sustainability?

Lee Coker, a project manager for corporate partnerships at EDF led a luncheon discussion at the CERES 2013 conference. He pointed to three key drivers for private equity firms to engage their portfolio companies on sustainability issues. First, competitiveness - private equity firms are very competitive, he says, and seeing that one of their peers is engaging and performing on the issue really helps get the other companies on board. Coker mentioned in particular Kohlberg Kravis Roberts (KKR), whose sustainability strategy, according to him, set the mark for the industry.

Second factor: operational improvement and cost savings. To illustrate that point, KKR provides detailed results on their engagement: $644 million in financial impact, 1.2 million tons of GHG emissions avoided, and 13.2 million cubic meters water use avoided through 16 of their 25 green portfolio companies.

Third factor: institutional investors are putting pressure on private equity companies to pay more attention to sustainability. In a context where competition for capital is stiff, having a good sustainability strategy to show for can be a decisive advantage for a private equity company in securing support from large investors.

Tools of the trade

Publicly-traded companies are relying more and more on standardized reporting framework to present and benchmark their sustainability efforts, using the Global Reporting Initiative (GRI) or the UN Principles for Responsible Investment (PRI).

To address private equity’s specific needs, EDF, in partnership with consultants from Irbaris, developed a simplified tool for private equity firms to assess how their portfolio companies were performing on a number of qualitative metrics and define the building blocks of an Environmental, Social and Governance (ESG) management program. The tool, available for free on the EDF website, covers leadership and management along with investment process and reporting. Compared to the very thorough – and at times overwhelming – GRI reporting framework, EDF’s tool provides more hand-holding and questions adapted to the governance and management practice of privately held equity.

Much work remains to be done

While EDF fights the good fight, many private equity companies are yet to pay attention to the broader issues of ESG for their portfolio. What do you think are the best way to engage privately held companies? Consumer power or investor peer pressure?

[Image credit: Images_of_Money, Flickr]

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Emilie Mazzacurati is Managing Director of Four Twenty Seven LLC, a consulting firm specializing in carbon management, climate risk and climate adaptation. Emilie is a Certified GRI Reporter and supports companies in their sustainability reporting and strategy development, with a focus on the risks and opportunities brought about by climate change.