Environmental, social, and corporate governance (“ESG”) considerations are increasingly crucial for alternative asset managers. While still in its adolescence, impact investing – whether screening potential investments for ESG risks or integrating ESG opportunities into investment strategies, is here to stay. Asset management firms, large and small, are inundated with positive and negative incentives to articulate, abide by, and document compliance with ESG policies.
Whether a firm invests through multiple strategies and product formats, has tens of billions of dollars of discretionary capital, or is a first-time manager of committed capital, it must manage constituencies with diverse ESG expectations. Larger firms, particularly with European Union-domiciled investors, are probably more accustomed to ESG considerations. Much of the origin of and leadership in ESG principals comes from European institutional investors. For smaller firms or those whose investor base is evolving, they may have yet to consider implementing ESG policies. Beyond the implications of ESG to financial sponsors, small, middle-market, or founder-managed businesses positioning themselves for private equity investment likely don’t appreciate how ESG considerations could impact private equity’s valuation of or are even willing to consider backing the company.
It’s time for ESG’s next application: including ESG principles and considerations in the means and methods that operating businesses are positioned for private equity support. Over the coming years, countless large and small founder- or employee-owned companies will seek institutional capital, whether private equity for a change of control, private debt for growth or recapitalization financing or any number of other sources. Similarly, the number of businesses currently owned by lower or traditional middle-market equity sponsors positioning for sale to a more prominent financial sponsor (which may scrutinize potential investments based upon ESG policy considerations) is significant.
In either scenario, there is a compelling reason for companies considering backing and financial support from fund sponsors to acknowledge how their business would be viewed through the ESG lens. That picture could be the difference between a term sheet or letter of intent and a polite “pass,” not to mention its impact on valuation or pricing. It would be disingenuous to suggest that all small or founder-owned businesses implement institutional-quality ESG policies and programs. On the other hand, shouldn’t a business owner or financial sponsor preparing a company for the market by proactively addressing real or perceived concerns make ESG a part of that preparation?
Thoughtful business owners and management teams entering the debt and equity capital markets are beginning to do just that – candidly assess how an investment in the company would be viewed by an institutional asset manager with an ESG policy. Once a company has an honest view of its ESG strengths and areas for improvement, the company can lead the ESG discussion with the potential investor. Imagine being a private equity sponsor, navigating a new policy area (ESG) while screening a potential investment. Then, imagine that company’s management team presenting its ESG strengths to the investor, along with a plan to address potential ESG weaknesses. Not only does the company seeking capital demonstrate competence and foresight of management, but it has also distinguished itself from numerous other companies competing for that capital.
Most, if not all, alternative asset managers are still unpacking the incremental complexity and level of governance that ESG policies and expectations impose on their respective platforms. Fund Finance Partners has not only observed how ESG factors can make a marked difference in institutional (debt and equity) capital raises; we have advised institutional managers on how to seize control of the ESG narrative with their potential investors and highlight their comparative advantages to drive successful outcomes.
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