Knuru Capital and Clyde & Co discuss how ESG is becoming increasingly important in venture capital investment and share some of the key considerations for VCs and companies looking to raise investment.
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There is an increasing push towards a tangible commitment to ESG (Environmental, Social, and Governance) in the Middle East which reflects a broader shift towards sustainability in the region in general and in the GCC area in particular. Driven by a desire to decrease reliance on fossil fuels, ESG is gaining more traction in the post-Covid-19 pandemic era which exposed society’s fragility and the impact of business disruption on our daily lives.
For the past few years, the UAE has been hosting global events aimed at facilitating and accelerating sustainable development such as Abu Dhabi Sustainability Week. In Saudi Arabia, the transformative Vision 2030 has been advanced as a sustainable vision for its future with sustainability at the heart of everything the Kingdom does, from policy development and investment to planning and infrastructure. As a result, ESG is being prioritized in the context of investment discussions. With governments doing much more to adopt and promote ESG, investors and companies in the GCC are recognizing that ESG considerations are core to the business strategy as opposed to “nice to have”.
Over the last 24 months, we have witnessed tremendous growth in venture capital investment in the Middle East (particularly UAE and Saudi Arabia). Some of the key ESG themes we have seen emerging are:
Differentiator: As the expectation for sustainable investments increases, it will become increasingly important to be able to demonstrate ESG credentials to improve the chances of seeking follow-on funding or a buyout/exit (as highlighted in a PwC article). There is an upward trend for listing authorities to require greater ESG disclosure and therefore a well-considered ESG strategy could be key. For newer VC funds, the ability to demonstrate alignment with an LPs stated values and responsible investment policy may help them stand out.
Consumer behavior: Consumer expectations are shifting and buying decisions are being frequently led by sustainability and net zero considerations. Businesses often need to scale quickly and therefore a strong set of ESG credentials will be vital in attracting (and retaining) customers. At the corporate level, procurement teams are showing an increased focus on ESG criteria.
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Long-term value creation: VC funds have a unique opportunity to accelerate the growth of disruptive businesses. By embedding ESG considerations as a core component of business strategy, high-growth businesses are more likely to be resilient to future regulatory changes. VCs also play a crucial role in evaluating the extent to which a company’s product or service may have unintended negative consequences for stakeholders.
Due diligence: A critical part of any investment decision will be to undertake due diligence. In the Middle East, LPs and sovereign wealth funds will likely place greater emphasis on ESG. There are, however, inherent challenges to ESG having swift take-up amongst VC investors because in many cases, the underlying technologies being invested in (e.g. web3, blockchain) are so novel, and established frameworks are not in place. This is where VCs can work with companies to develop a bespoke ESG framework/action plan for ongoing compliance.
Mitigation of risks: There is increasing competition among VCs to secure the best deals and portfolio companies. This means that VCs are often under pressure to make quick investment decisions. As highlighted by an article in World Economic Forum in 2022, one particular risk area is the use of AI by technology startups due to its potential for increasing bias/discrimination and other policy issues such as human rights. A strong ESG framework can help investors evaluate those risks at an early stage of the investment lifecycle and put measures in place to mitigate such risks.
Overall the outlook is positive and we expect to see a greater focus on impact-driven investments.
This article is written by Chadi Salloum (Partner, Clyde & Co), Krishen Patel (Senior Associate, Clyde & Co), Alain Dib (Co-Founder and CEO, Knuru Capital), and Victor Sunyer (Partner, Knuru Capital).
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