Why is ESG important when evaluating a private equity investment?

ESG is becoming more and more important, and investors care about this more and more as any ethical or environmental conflict could result in a negative backlash from consumers / customers, a tarnished reputation, or even legal consequences. It is, therefore, crucial to avoid investing and / or buying companies with poor ESG practices.

It is not uncommon for ethically questionable companies to be marketed to PE firms. Everything from companies directly or indirectly profiting from armed conflicts to private prisons for juvenile adolescents is presented in teasers and CIMs to PE firms. It is crucial that PE firms know where to draw the line because there is a significant tail risk to revenue if a portfolio company is caught up in a publicity scandal, or institutional investors in the fund may worry about damaging their reputation. These issues could even cause the company to fail and default on its interest payments as a result of clients and customers leaving.

It is not entirely uncommon that members of senior management may have a criminal record for example, or are involved with corruption / bribes. It is better to find this out sooner rather than later to avoid wasting time and dollars in due diligence.

Therefore, PE firms should analyze each potential investment’s ESG performance in several areas: labor, supply chain, environment, inclusion, and transparency. They can outsource some of this due diligence to third parties. Some basic screening and research should be performed by junior staff to ensure there are no large reputation risks and other ESG issues.