Back to basics
In an era when stakeholders are increasingly concerned about greenwashing, why should the G in ESG be brought into the spotlight?
The private equity model’s success relies on implementing strong governance in portfolio companies. And, while that has always been the case, the attention given to social and environmental matters has meant that the industry has talked less about the governance element of ESG. Yet there can be no measuring and monitoring of positive and negative social and environmental aspects of an investment without strong reporting mechanisms – something that requires a firm grip on governance.
Clearly, a private equity firm’s own governance and that of its portfolio companies is an area of intense due diligence for LPs. This is particularly true of funds operating across the African continent, where a fund’s processes and systems need to be particularly robust, given the challenging political and macro picture in some of the region’s markets. This is why, for some GPs and LPs investing in the region, governance needs to remain top of the agenda and continue to be a talking point.
“When we invest, we are looking for a values system,” says a Private Equity Fund Head at a DFI. “That’s about a strong track record for business integrity and good governance, in particular, with demonstrably strong ESG standards across this.”
“Private equity has experienced its share of failed or problematic governance in the past few years, not only among portfolio companies, but also among GPs and funds,” adds Hannah Subayi Kamuanga, Partner at Launch Africa Ventures.
“As an industry, we now better understand the need to put in place the right corporate governance structures to avoid capital being misused and avoid reputational risk.” She adds: “We also need to ensure that management teams and fund managers are properly incentivised and aligned to create value. This is critical to ensure that African private equity and venture capital industry remains credible. This implies clear and transparent communication with the LPs. This was probably lacking a bit in the past, but it is getting better now.”
Past scandals may have sharpened some managers’ focus on governance, but many are now having to push harder in this area as regulatory pressure in some regions starts to bite. The introduction of the Sustainable Finance Disclosures Regulation (SFDR) in Europe is one example. “If firms want to attract the right type of capital, it behoves them to focus on all three of the E, S and G,” says Yoza Jekwa, CEO and Co-Founder of Thrive Capital Partners. “The advent of regulation will affect firms seeking to raise capital from European LPs because it will affect the lens through which they will be scrutinised.”
It’s a point picked up by Alison Klein, Independent Adviser and Former Manager of Private Equity at FMO. “If you say you are an impact fund, what impacts are you targeting and how are you measuring them?” she asks. “And how do you manage the potential negative impacts of your investments? If you invest in areas with high social risks due to labour conditions or interactions with local communities, or with environmental risks like impacts on soil or air, you need to assess, measure and manage them; you need good governance. The good news is that, for the right managers, where the intentions are aligned, development finance institutions will be willing to go on a journey with managers to help them with training and putting in place the right systems.”
Governance has always been the foundation of value creation in private equity, adds Klein. “But what does it actually mean?” she says. “It’s a system to make sure you are doing what you say you are going to do. You can have a strategy and intention, but how are you going to get there in the right way? How are you going to measure progress? And how are you going to course correct if needed? Good governance is at the core of value creation – it takes a business to the next level through proper strategic and financial discipline, tax reporting and managing social and environmental risks.”
“When money talks, there is clear influence,” says Jekwa. “At portfolio level, firms need to come in and enhance company governance and put in place the right policies – robust governance will translate into a better valuation at exit.”
But fundamentally, it’s about trust. And while regulations and the need to create value in portfolio companies are major drivers, the fact that GPs are asking their investors to commit to a blind pool of capital over a minimum ten-year period means that the private equity industry can’t afford for the the G of ESG to be overshadowed. As Klein says: “When you are investing other people’s money, you have to be very clear about what your investor expects from you, and put the systems in place to make sure you deliver.”
If you say you are an impact fund, what impacts are you targeting and how are you measuring them?
