Private equity leverages responsibility

Not so long ago, the private equity (PE) industry was thought somewhat behind the curve relative to the corporate sector in its management of environmental, social and governance (ESG) issues. But this perception is no longer justified, as a growing number of PE houses view ESG issues as presenting an opportunity for boosting portfolio company value.

In a survey of PE houses published in March 2012¹, we found that a resounding 94% of participants believed that ESG activities could create value. A further 88% anticipated that investors would pay growing attention to ESG issues over the next five years.

At a time when fund-raising is tough and investment difficult, we believe responsible investment (RI) is becoming increasingly important. PE houses are making it a way to differentiate themselves and gain access to capital. They are also using it as a way to manage risk, save costs, comply with regulations and introduce the right ‘tone from the top’. Notably, all of the PE houses interviewed, look into ESG issues during investment appraisals. But our survey suggested that US and European PE houses take very different approaches to managing them during the hold period. US-headquartered participants tend to focus primarily on realising value through eco-efficiency measures, which concurrently reduce environmental impacts and cut costs. Their European counterparts, by contrast, incorporate a broader range of ESG factors.

A steady evolution

Yet, our conversations with the senior management of 17 leading and mid-tier PE houses in Europe and the US, which took place between November 2011 and January 2012, showed that the approach to ESG remains a work in progress. Importantly, only 40% of the PE houses interviewed had put systems in place to collect data from portfolio companies to measure the value created by ESG activities.

Some PE firms have successfully measured eco-efficiency-related cost savings (e.g. waste reduction, raw material reduction, reduced energy/water use) and report these savings in financial terms. But even the more advanced PE houses are struggling to measure the intangible benefits of ESG initiatives. A few PE houses are beginning to measure ESG improvements at their portfolio companies by using qualitative techniques, building a picture of progress from year to year.

While PE houses have made considerable advances in implementing RI strategies over recent years, the survey findings indicate some fundamental areas for improvement. In particular, 50% of survey participants did not have an ESG/RI policy and 47% did not report publicly on their programmes.

Recommendations for improvement

We have four recommendations to help PE houses and their portfolio companies to overcome barriers and to enhance their ability to create value from responsible investment strategies.
  1. Access the right expertise
    Many interviewees cited lack of in-house capacity/expertise as a key barrier to implementing an RI approach. Given the current economic climate, few PE houses are likely to build in-house RI teams, so they need to find innovative solutions, for example by forging partnerships with NGOs, providing RI training to deal teams, hosting knowledge-sharing conferences for portfolio companies and engaging external expertise.
  2. Consider the best way to act on findings from pre-acquisition ESG assessments
    All respondents reported undertaking some type of ESG pre-acquisition due diligence. But they need to build these findings into the 100-day plan (or other targets set for the hold period). Unless they do so, there’s a risk of sidelining ESG action points as niche issues, rather than integrating them into core business strategy and practice.
  3. Measure the financial value created
    Existing valuation methodologies can quantify both the intangible and tangible value that ESG management creates. But undertaking any valuation requires data, so PE houses must be able to systematically collect relevant ESG and financial data from their portfolio companies.
  4. Ramp-up reporting
    PE houses can benefit greatly from the corporate sector’s advances in both sustainability and integrated reporting. While some PE houses have tended to report case studies, reporting should be balanced rather than just highlighting ‘good news’. Finally, PE houses could consider engaging proactively with LPs to help shape and streamline future RI reporting to LPs (rather than being on the back foot and struggling to report similar but different information to individual LPs).

A positive progression

Right now, the industry’s overall response to RI and ESG issues remains in its relatively early stages, but it looks like this picture may be changing for the better, soon: 94% of PE houses surveyed said that their attention to ESG issues will rise over the next five years. What will they be focusing on? Many are looking at all the right areas, citing policy development, valuation and reporting as areas of focus for 2012 and beyond.

Making improvements in these areas is likely to improve the saleability of PE assets, even if there’s no clear evidence that it enhances exit multiples.

¹Responsible investment: creating value from environmental, social and governance issues March 2012.


Phil Case

PwC (UK)
Tel: +44 20 7212 4166