Startups need an ESG strategy

Startups are often just trying to survive – do they have time to care about ESG? Yes. Indeed, they must be aware of the significant risks and opportunities in their industry, which is essentially what a prudent ESG strategy offers. Startups should start by identifying their purpose and then linking that purpose to ESG considerations, for example by identifying risks to avoid and manage. All startups need to consider their carbon footprint, make sure they treat their employees well, and have various boards that oversee them.

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

Quite the contrary: start-ups have an advantage over large companies whose “installed base” of assets, products and culture must often be broken down to be consistent with ESG principles. Startups can build it from the start, avoiding costly rework later. And they can do so in a way that accelerates the urgent search for product-market fit instead of distracting from it.

Here’s a new approach for founders to launch their ESG journey.

Start with the goal

Purpose crystallizes the unmet need a startup addresses and the unique strengths it brings to achieve it. Purpose replies: “What would the world lose if the startup disappeared? Could competitors easily replace it or is there something unique it brings that customers will pay for that is deeply rooted in its core strengths and value proposition? The purpose is much more than branding and public relations. 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 compromises in moments of truth. Startups often benefit from a strong sense of purpose given their closeness to a founder’s initial passion for solving a problem in the world.

Marry the objective with the ESG

ESG is different from Purpose. ESG frameworks suggest How? ‘Or’ What you direct your business to achieve your goal and strategy, and what exposure you have to certain risks. It provides an implementation framework to guide business decision-making. The goal without ESG is neither measurable nor strategic. It’s not anchor in business. On the other hand, ESG without purpose is not concentrate enough about the few crucial topics that underpin the startup’s strategy. It’s just a laundry list. Goal helps founders identify the few dimensions on which the startup chooses to “win” over just being a good citizen.

Identify material risks

Founders should start by identifying key risks to avoid and manage. Basic research by George Serafeim in 2015 emphasized that efforts should first focus on the risks that are Material to the specific sector/activity of a startup. The SASB and other frameworks help identify these material ESG risks. Startups should start there and try not to boil the ocean. Failure can be terminal. For example, data privacy is a significant risk in the EdTech space. Dozens of startups risk losing major government contracts as a recent report by Human Rights Watch on the EdTech sector found that many were selling personal data to advertisers that they had collected from minors using their educational applications, breaching the most basic expectations of privacy under ESG’s ‘Seau G’ (Governance).

Regardless of the sector startups are in, our research suggests that the following short list of material risks should be prioritized because they can have a high financial impact when executed poorly and because they overlap heavily with “typical” startup priorities.

On E: Startups must have a carbon/natural resource footprint objective.

Only 7% of startups have a net zero plan. And yet, it is a top priority for investors who themselves are under the greatest regulatory pressure for transparency in this area. Investors can only achieve their climate goals if the companies they invest in do so. Startups can easily track core resource usage through utility bills. Building net zero muscle early allows startups to build sustainability into their supply chains as they scale. It also protects against reputational risk from poor supply chain controls, avoiding what startup darling Daily Harvest faces today.

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

In an environment of acute labor shortage, the war for talent has never been so fierce. Companies that pay a living wage have 30% lower attrition during this Great Resignation period. Today, it is the most important ESG dimension for employees in the United States. Meanwhile, 40% of the workforce complains of burnout and other mental health issues. Inclusive cultures counter this. Any successful founder with more than two employees already promotes diverse viewpoints and a strong sense of belonging. Past challenges from WeWork and Uber are salient reminders of the negative impact of toxic crops.

On G: Startups need diverse advice and solid data security rules.

Increasingly, investors will require the startups they invest in to have diverse boards. It is the most publicly visible ESG metric that investors can track, so it is usually incorporated into their early due diligence processes and included in their own goals. Moreover, greater diversity on the board of directors is strongly correlated with better company performance.

Startups also need to incorporate strong data security and privacy policies. Startups have most often undermined customer trust by neglecting data security/privacy, triggering increased regulatory scrutiny in this area. Note the EdTech example above and myNurse, a healthcare startup shut down in 2022 after a data breach affecting 1.7 million patients.

Companies that outperform on ESG are tapping into five sources of value: lower risk, cost of capital and regulatory intervention, and upper the growth, attraction and retention of talent. Startups develop a competitive advantage by embedding purpose and ESG in their DNA from the start.

The purpose helps inform the “offense” about a few select areas of distinctiveness. ESG helps inform the “defense” in material categories. In any case, startups should cover specific bases, including climate goals on E, a strong social contract on S, and diverse governance and strong data processes on G. Optimally, the founder should clarify “ who” is responsible for implementation, backing up priorities with action, and reporting progress to their board along with other priorities.

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