ESG Criteria, OPM, and Startups

In many industries, the use of OPM (other people’s money) to fund growth is the norm. As a venture capital firm, that’s obviously our job. We deploy our limited partners’ capital into startups via a fund in order to deliver a return. While we have our own capital in the fund, the majority of the capital is OPM. In the world of real estate, this is even more so the case. There are very few real estate companies where 100% of the assets are owned outright. Likely, there are limited partners in a fund providing equity, and there is almost always a debt holder on the mortgage. 

There is a lot of capital being deployed globally, with a lot of opportunities that generate targeted returns. Investors are demanding more from their investments; targeted returns are the bare minimum. The focus is now on environmental, social, and governance (ESG) criteria.

ESG criteria are an indicator of the social responsibility of a company. The environmental criteria evaluate how environmentally friendly the company is, the social criteria evaluate the quality of relationships both within the company and between the company and the surrounding community, and the governance criteria evaluate the company’s leadership and use of money as well as the shareholders’ rights. Socially conscious investors can use this knowledge to help them decide where they’d like to invest. And they have been using it: according to the US SIF-Forum for Sustainable and Responsible Investing, between 2016 and 2018 there was a 34% increase in ESG-evaluated assets under management for a total of $30.7 trillion worldwide.

The “S” and “G” in ESG are super important, but they are not my field of expertise. So let’s look at the “E.” When evaluating how environmentally friendly a company is, we can look at criteria such as how a company manages waste and pollution, how well they use and conserve energy and natural resources, and how they treat animals.

So how does innovation factor into the equation? Since management of waste is one of the environmental criteria, we know that innovation to reduce waste is relevant. A company can use innovation to improve its ESG score. And they are aware of that; according to a report commissioned by the Business and Sustainable Development Commission, companies focusing on sustainable development include “industry, innovation and infrastructure” as being among their top two goals for being relevant to their business and having the greatest potential impact. The report also identifies $12 trillion in business opportunities for companies focused on the United Nations’ 17 Sustainable Development Goals. It lists innovation as one of the top two factors for taking advantage of this opportunity.

So innovation is a key factor in meeting ESG goals. And innovation is being adopted into real estate, although not as quickly as it could be. But there’s a problem here: companies are not necessarily providing enough data back to the real estate owners/developers to deliver to their fund managers. They may be providing data about LEED criteria compliance, but that just isn’t sufficient. Real estate owners/developers and fund managers need to know exactly how companies are meeting ESG goals above and beyond LEED criteria. This data is best presented through the use of a set of KPIs, or key performance indicators.

NAREIT studied all the frameworks for ESG reporting and distilled the KPIs down to their top 5 most frequent environmental KPIs. They are:

Climate Change Opportunities and Risk: A company’s strategy, planning, and policies for climate-related business risks and opportunities. Disclosures explain the tools and methodologies companies use to identify, assess, and address climate change, and how these approaches are integrated into overall risk management and business strategy

Greenhouse Gas (GHG) Emissions: Includes all greenhouse gas (GHG) emissions-related metrics and policies for a company across Scope 1 (direct, onsite), Scope 2 (purchased energy), and Scope 3 (extended indirect). Disclosures require verifiable information and standardized data for the emissions resulting from company operations and products, as well as descriptions of programs and policies seeking to reduce or otherwise mitigate negative emissions.

Environmental Policy: The presence and completeness of an organization’s environmental management policies, what they contain, and how they are managed. Disclosures describe company policies related to environmental protection, responsible building development, carbon pricing, supply chain, resilience scenario planning, compliance with regulation, and management/approval from senior leadership, among others.

Energy: Covers all energy-consumption related metrics and policies for a company. Disclosures include specific data and metrics on energy use and energy spend by source, with specific emphasis on renewable energy use. Disclosures cover programs and metrics related to energy reduction, efficiency, and conservation for all company operations and products.

Environmental Management Systems: Details the systematic management of an organization’s environmental programs, and whether or not an organization has a documented structure in place. Disclosures focus on policies and procedures in place to govern operations, tools and platforms to collect, monitor, and manage environmental data, and processes to evaluate and mitigate negative impact. Emphasis is placed on target-setting and continuous monitoring. (NAREIT, 2019)

For most real estate owners/developers that are evaluating any new technology or innovation, their key criteria is typically ROI. The providers of these innovations/technologies thus focus on presenting and tracking KPIs that drive ROI. Specifically to startups, it is important to start including KPIs related to ESG, as it could be a market differentiator if you can deliver the data to the real estate owner/developer for reporting back to their financial backers. Realistically, ROI is still the driving factor for purchase, but ESG could be a differentiating feature. But only if the ESG-related success is clearly reported through KPIs. 

There are three essential areas to focus impact/reporting: management of data, development performance, and operational performance. Development performance is focused on the design and construction process. How does your technology reduce waste during the design and construction process? Operational performance is focused on criteria post-occupancy. The big areas are around the consumption of natural resources like energy, water, etc. 

I was once told by a mentor that if you want to build something big, you can't just be concerned about solving your customer's problems. You need to focus on solving your customer's customer’s problems. In this case, that means the OPM (the funds and financial backers of your customer). If you can't provide reporting to leadership in a form they can consume, it doesn't matter how much impact you are actually making. When it comes to ESG criteria, providing great reporting based on clear KPIs is key.

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