June 20, 2022

Redefining the ‘S’ in ESG

By Evli Growth Partners
Our trainees traditionally write a blog post and this time is no different! Our most recent trainee Ellen Järnefelt writes about the S in ESG and how to lead the way in social impact.

Environmental, social, and governance. In ESG, the ‘E’ is often most clearly measurable, as the units and the causal relations are often quite forecastable. At least compared to the ‘S’. ‘Social’ usually refers to managing relationships with workforce, the societies in which one operates, and the political environment – in a way, it could be seen as analogous to ‘stakeholders’. Either way, investors and startups often seem to struggle in conceptualizing their take on the ‘S’, creating an absence of focus and measurement. Compared to the ‘E’ or ‘G’, the market might lack a clear framework and consensus in pricing the ‘S’.

When assessing social impact, we’re often talking about long, causal chains, and how and when it translates into money and shareholder value, is often unclear. Startups and scaleups are also inherently businesses that might fundamentally change in nature when growing from 0 to 100, and many might be unprepared for the social impact they have after reaching a certain size, or after they pivot their businesses towards unprecedented directions. The scope of the ‘S’ has also significantly widened in the past few decades, as all entities in the function have become more interconnected and -dependent, and issues related to modern supply chain systems, such as general human rights and equality questions, have become vital to address.

So, if you want to lead the way in social impact, where should you look?

The intuitive starting point is inside your team. The ‘S’ practices within a business are often a good indicator for corporate culture – inclusive culture tends to exist within companies that also have strong social practices. Freshly-founded companies generally have the best chance of creating impactful frameworks. The larger the organization, the more difficult it is to embed impact into operations.

Recruiting is often the first step. Job ad and interview inclusivity are crucial when trying to target employees in an equal way, and things like wording in job ads or language used in interviews have significant impact on who applies, or who shines in an interview. Creating an inclusive framework for performance evaluation and being conscious about internal communication habits and ways of working also has a big impact. Startups are also starting to cash in on these aspects – focused on making company culture and working policies more transparent with their platform, Flexa just raised a £2,3M Seed.

Then comes the product. Especially with scalable tech products, it might be difficult to predict the possible loopholes or malfunctions that might lead to negative impact. As global IP and governance challenges grow, it’s become increasingly challenging to take on the large-scale tech projects that will really drive humanity forward.

Some startups have even decided to establish their own external ethics board, some already from a very early stage - spurred by the desire to not have similar hate speech and disinformation issues on their platform as Facebook or Twitter, Anyone created an ethics board when they only had 12 employees. These kinds of boards help businesses anticipate and mitigate any potential negative impact of their products, and have traditionally existed only in large corporations, medical or biotech companies.

In the recent years, we have witnessed many products -and especially platforms- reach significant negative or at least questionable social impact. Think Cambridge Analytica or Spotify’s struggles with their quite recently exclusively licensed Joe Rogan Experience. Another example is delivery businesses -say, Wolt-, who have been facing scrutiny on the position of their couriers, and within current legal frameworks, it’s hard to quick-fix.

Takeaway: some founders happen to be building their businesses and essentially, products, on top of colossal continental plates, and when they reach a certain phase or volume, they are suddenly an entity with a massive social impact.  They are then expected to play the part and have the social impact part figured out – as they should. The inherent challenge is that these things are hard to predict.

So, how should startups be assessing their products to be able to see ahead?

The most important thing is realizing that products never exist in a vacuum. They interact with other products, lifestyles, consumption habits, communities and other local or global factors – known or emergent. It’s important to adopt a systems thinking -approach to your product: what kinds of social micro or macro phenomena might our product cause or enable if we manage to scale big? What’s the best-case scenario, and what’s the dystopian scenario?

Systems thinking in terms of externalities is often difficult, as the value created in those processes might be difficultly translated into shareholder value – at least on the short term.

VC’s inherent logics is not always an alleviating factor to this puzzle. Founders lose some chunks of control when they acquire funding, and might sometimes be under the pressure to go public. If the investors aren’t fully committed to the company’s long-term ethical goals, the founders might sometimes face uncomfortable compromises. Same applies to all stakeholder groups – many entities can come in and change the course of the business.

In an attempt to tackle this issue, strongly impact-oriented companies like Sharetribe, Nevi or Vyl have adopted an alternative way - the steward ownership model. Steward-owned companies can never be bought or sold, but investors can earn returns on their investments in the form on dividends or capped returns.

VCs can still also play the opposite role – with an impact- and ESG-committed investor, many “middle ground” startups have a lot to gain. Investors can also offer their long-accrued knowledge on how to make your business more responsible, sustainable and positively impactful.

Funds with a strong ESG-focus – and often even an own ESG specialist – can showcase their impact-commitment in multiple ways: in the process of selecting and screening the investments, in including impact into the valuations as well as in being consistent when creating the term sheet and defining the metrics and monitoring practices.

So, “How to manage your ‘S’ – a checklist”: Hire well, make sure your internal mechanisms – no matter how small- are aligned with and built to support your mission, design your product to work well with your full surroundings, and make sure to gather stakeholders who truly back your mission.

Simple, right?

- Ellen Järnefelt

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