Private Equity Talks, the podcast of Real Deals and The Drawdown, has covered a range of areas affecting the mid-market in the first half of 2022, specifically focusing on the impact of ESG on assets and the next wave of thought in sustainable investing. Here’s a round-up of some of the key topics discussed.

EMBEDDING ESG INTO VALUE CREATION

Some GPs are finding it difficult to engage with management teams and founders that do not have a plan to incorporate ESG into the value creation strategy. This is a 180 degree turn on the situation five plus years ago, where PE investment teams may have found it trickier to convince management teams the pros of ESG, and why it mattered.

Beth Houghton, head of impact fund and partner at Palatine, explained: “When we first started to talk about ESG twelve years ago, there was more resistance from management teams. It was a new concept for many people, particularly at Palatine because we’re investing in the lower mid-market, so it did take a bit of effort to convince management teams to take on the initiatives and to take it seriously. In those days, we used case studies a lot, so we explained to management teams the benefits ESG could bring to their organisation.”

She continued: “Now, management teams are coming to us in the first meeting saying they like us because of our ESG stance. That’s what’s interesting about the part of the market we invest in, I think there’s a lot of management teams who are really wanting to do the right thing, but maybe they don’t have the resources internally or they don’t have the knowledge to do that, and that’s where PE houses who are taking a leading stance on ESG can help and support management teams through that process.”

ESG PREMIUMS AT EXIT

A number of GPs are finding that by improving the ESG credentials of a portfolio company during the holding period, they can bargain for greater returns at exit. This sustainable edge, or ‘ESG premium’, can drive a higher price, according to a recent report by GCA Altium, titled ESG: dealmaking with impact. The report states that alongside the obvious long-term benefits to the environment and society, ESG is a hidden success factor within exit transactions. It states that “strong macrotrends and the continually increasing appetite from investors mean that ESG assets are valued at a premium.” The report continues that the “ESG premium” could add up to 15 per cent on money multiples of European assets.

Erik Osmundsen, partner at Verdane, explained. “We believe in the moral obligation, we like the marketing ploy, but what we’re going after is the competitive edge. With that, we’ve seen businesses make 5x their Ebitda, based on moving this dialogue away from a prize only public tender market, into a partnership-oriented sustainability dialogue. When you get to the multiple expansion that is based on growth and ESG, then that is a very important mix.”

For impact investor Palatine, the GP tracks the progress of ESG improvement within its portfolio, to discover how much of an improvement on returns ESG is making. Houghton said: “We do numerical scoring across our six pillars for each of the businesses we invest in. We update that score on an annual basis, and then we update it when we exit, so we can do a review.”

She added: “We’ve just gone through a process of mapping that to the returns. We found a really strong correlation across those metrics, not only with companies that score better on ESG, but also the companies that improved the most as well.”

THE JUST TRANSITION

Bridges Fund Management is investing along the theory of the Just Transition. As defined by Nick Robins, of the London School of Economics, as the ‘how’ in approaching net-zero, Michele Giddens, co-CEO at Bridges, told Real Deals: “I think this is the next wave of thinking in terms of sustainable investing.”

“Fortunately, many more investors these days are thinking about climate impacts in their investments and making net-zero commitments, and that’s incredibly important. The latest IPCC report suggests that investment in the shift to a low carbon world is about six times lower than it needs to be,” she explained. “A Just Transition takes this to the next level. It’s about ensuring that the benefits and the costs of transitioning to a green economy are distributed widely and fairly, meaning that when we think of environmental sustainability in choosing investment, and how we run our investments, we also think about what that means for social inclusion, decent work, and poverty eradication.”

The Just Transition philosophy isn’t just focused on the E element of ESG, but also the S and G. Giddens explained: “When we look at an investment, we look at the core impact thesis, and that thesis must either have a strong environmental dimension, or a strong inclusivity dimension. Our bullseye, if you like, of our impact thesis, would combine both of these: a positive impact on the planet and inclusivity. AgilityEco is a really good example where it does both related to inclusivity, as well as to planet-related themes.”

AgilityEco, has been a Bridges portfolio company since 2019. As a provider of fue, energy efficiency and low carbon services to vulnerable households across the UK, the business provides financial advice, as well as arranging the installation of energy-efficiency measures (including better insulation) in a bid to make the cost of living crisis and rising fuel costs more bearable.

“We were very attracted to AgilityEco because we felt that its growth potential was going to be enormous, as well as having a very positive impact on people and planet,” commented Giddens. One key takeaway of Bridges’ partnership with AgilityEco in just the last few years has been its resourcefulness in measuring impact. Sharon Johnson, COO of AgilityEco, told Real Deals that this is the one way they’ve been able to really improve the business.

In 2021, AgilityEco made £200m of interventions, totalling £7,000 per household in lifetime savings on their energy bills. Johnson explained: “Where Bridges has really helped us is in bringing us that focus and ability to measure our impact.”

Another key area where Bridges’ philosophy of the Just Transition and value creation have aligned to support AgilityEco is in its support of the individuals within the business. Johnson added: “We’ve introduced an employee ownership scheme through Bridges’ very good advice, and we’re getting great support on our application to become B-Corp certified.” Investing through the Just Transition can be universally implemented across the asset class, it is suggested.

Giddens concludes: “Ultimately we are all investors, and we are looking to invest in companies that can deliver attractive and sustainable financial returns to our investors. What we hope to do with all of the companies we work with is to identify those winwin opportunities where taking decisions that are more inclusive and that are better, in terms of the planet, can transform the commercial success of the business.”