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Our experience applying ESG in Venture Capital

Lorena Suarez, Managing Partner, talked to Blue Future Partners about our application of ESG (environmental, social & governance) criteria in our investment process. 

Do you see any differences between the LatAm and US tech scenes when it comes to ESG?

There is a global consciousness now that companies operate in a broader context and have an impact on their communities. The main difference between the US and Latin America is in the institutionalization of ESG practices and principles. Latin America is now in a “sensitization” stage, where ESG is part of good practices and promotional activities. In the US, on the other hand, these principles are more institutionalized and it is mandatory for companies to report their track record. As one specific example, President Biden signed an executive order in 2021 to include climate-related risks in the assessment of financial risk.

In Latin America, the context is different. The pandemic has delayed the ESG debate greatly, placing it in a secondary position against the region’s short-term concerns. In 2020, the economic contraction here was twice as big as the global average. However, I think that the need for companies to consider their environmental and community impact and transparently manage their economic activities is real, and we should not escape from it.

In the VC industry, the investment boom in the region produced a cascading effect. The confidence placed by US funds in Latin American startups has promoted the fulfillment of those investors’ compliance requirements, including ESG. This has also encouraged the local funds to catch up and take action. Thus, this sector can take the lead in institutionalizing ESG much earlier than corporations or governments. Latin America, as a late adopter of ESG, has the opportunity to learn from the experiences of the countries that opened the way and adapt ESG frameworks to the region’s reality.

Do you have any specific ESG framework in place? How do you assess the impact potential of startups you are screening?

ESG principles are ingrained into our entire investment process, from selection to funding and exit. In terms of selection, we have defined two lists: the exclusion list, which penalizes areas or activities which do not match our values; and the powered list, which positively values diversity and founders from underrepresented communities, with the objective of “double clicking” and avoiding biases. In our selection evaluation, ESG principles are measured with the same importance as financial indicators and an ad hoc Impact Council is called in order to give an opinion about the startup’s current impact and potential. In this way, the Investment Committee can make a well-informed decision regarding ESG.

“Because we are an “impact-driven” fund, our objective is that every startup employs good practices of ESG principles and permanently monitors them…”

Once the startup is part of our portfolio, we commit ourselves to measuring and managing the main indicators and helping in their process to achieve sustainability. We have developed an ESG framework which allows us to evaluate startups individually, working with each one’s particular risks and opportunities; and as a group, creating a map where each company in the portfolio is positioned as a “leader”, “follower” or “laggard”. The methodology used is “scoring”, in order for each company to make comparisons to its past performance and that of the general portfolio. We have indicators that allow us to measure the transparency and active management that each company grants to environmental, social and good governance factors.

In this way, we can monitor the state of each startup and its annual progress in order to achieve “zero laggard”. Because we are an “impact-driven” fund, our objective is that every startup employs good practices of ESG principles and permanently monitors them as a key rule of the business.

How do you help startups scale their impact after investing? Can you share some specific examples of how you collaborate with them?

After the investment is carried out, we have two key ways to increase transparency and the management of ESG principles. First comes measurement. ESG indicators are reported quarterly together with financial indicators, giving them the same relevance and priority. Once a year, an interview is carried out to reassess the indicators and to identify new risks and opportunities. All information is summarized in an Impact Case, which startups can use during subsequent fundraising.

“There is an important obligation we have as a VC fund, and that is to work internally on the same criteria we evaluate in startups.”

Our second way of collaborating with startups is a dedicated Impact Council. Our startups have an ad hoc council made up of experts on impact and on the startup´s industry. In this way, they can not only identify risks and opportunities, but develop an action plan in order to use and mitigate them.

This joint work during the investment period gives the startups valuable information that helps them gain new rounds with those funds that value ESG principles.

How do you address ESG responsibility in your internal operations?

There is an important obligation we have as a VC fund, and that is to work internally on the same criteria we evaluate in startups. For a long time, it was thought that this was not necessary, as our teams were small and horizontal. However, we have recognized the need to evaluate Alaya Capital using the same framework as our portfolio. And so we have developed new initiatives for internal training, selection handouts, staff hiring with no biases and anti-discrimination policies, among others.

How is the discussion around ESG evolving in the Latin American VC community? What needs to change so that more funds adopt ESG practices?

As I mentioned before, VC investors are a step ahead on ESG matters, as they are becoming more related to US-based or multilateral funds that promote these principles and encourage their application. However, there needs to be more debate and good practices to promote the adaptation of these principles by the funds of the region. There is a large amount of confusion about the key principles, as it is believed that ESG principles are only for impact startups, and sustainability is not perceived as a responsibility of every actor of the ecosystem. But we currently have a big community, and I believe that the information can be rapidly obtained if we put this issue in our agenda.