Integration of socially responsible investments in venture capital and private equity

Cyprès à Cagnes - Henri Edmond Cross

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In many previous entries we have already seen what socially responsible investment (SRI) is, which includes the so-called environmental, social and corporate governance factors (ESG factors) in their investment procedures to promote sustainability. Among others, you can see the entries “The EU's plan for a clean and sustainable economy, ESG and SRI” and “Implementation strategies for socially responsible investments”.

The purpose of this entry is to comment how venture capital and private equity firms (limited partners) can or should adopt criteria on socially responsible investment.

The main instrument for adopting SRI in a venture capital or private equity firm is to include ESG factors as part of the entity's investment policy. Consequently, ESG factors become mandatory for the entity. In current practice, it is already common to see certain ESG factors in the investment policy, but with a very generic scope and non-binding nature. However, this should not lead to the conclusion that incorporating ESG factors in the investment policy is inadequate or insufficient, but that such incorporation needs to be more complete, detailed and entirely binding.

As the scope of the content in the investment policy is limited, this policy should include specific obligations that ensure the effective conditioning of investment and disinvestment procedures. All this, together with the traditional aspects included in the investment policy. In addition, the investment policy must include an ESG mandate, with the development of ESG factors.

Another relevant instrument for venture capital and private equity firms regarding sustainability is the adherence to principles, guides and codes of conduct. Initially these principles were quite generic, such as the “UN-UNPRI Principles for Responsible Investment”, but over time more specific guides and codes have emerged, such as the “UN 2020 Technical guide for limited partners: responsible investment in private equity”.

To fully integrate SRI by limited partners, it is highly useful to adopt both the incorporation of ESG factors and to adhere to sustainability principles and codes of conduct.

The use of internal codes of conduct and operating regulations for venture capital and private equity firms is also a key instrument for SRI. These documents should include mandatory practices of the employees and training sessions, so that the entity's operations are always aligned with SRI. These practices include the use of due diligence checklists with ESG factors, the use of enterprise value formulas with variables linked to ESG factors, training employees in new sustainability developments, etc.

There are other instruments for venture capital and private equity firms to strengthen and guarantee its functioning in accordance with SRI, such as the inclusion of certain provisions in the bylaws. In this regard, certain mentions could be included in the bylaws corporate purpose, it is also possible to mention the creation of a committee on sustainability or a shareholders’ right to receive information on sustainability.

Finally, it should be borne in mind that there are legal and regulatory obligations that contribute to the objectives of SRI (such as transparency obligations). However, to highlight these legal obligations is not the purpose of this entry, focused on highlighting the practical particularities commented.