“Exit, pursued by a bear”, why ESG influences IPO success

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As the famous Shakespeare quote goes to show, a successful exit is only as good as what follows. In the context of the recent IPO for Deliveroo, a much-hyped listing fell dramatically in its first days of trading as questions around overvaluation and persistent ESG risks pursued the UK-based tech company.

Exactly how bad was the IPO? Its first day performance ranked it 1,765th out of 1,775 IPOs listed in the UK, according to the think tank New Financial. Although there are multiple reasons why its stock market debut flopped, the number and size of significant potential investors (Aviva, Legal & General, M&G amongst others) highlighting ESG concerns as a major factor, means other private companies and their investors should sit-up and take note of the influence that ESG has on exit valuations.

As experts in ESG and the private markets, we have been asked by our clients: why would a fast growing company such as Deliveroo attract so much private capital, but be shunned by investors when listing, despite the ESG risks being largely the same?

While we want to emphasise the clear links between ESG risks – in Deliveroo’s case, employment rights in particular – and financial valuation, the issue in focus in this post is the difference between how the public and private markets differ in their approaches towards ESG.

ESG scrutiny: private versus public markets

There is a huge amount of variation within both private and public markets, let alone between the two. What we can say with confidence is that private market investors face fewer demands and scrutiny in terms of ESG disclosure. Historically, their only real pressure point, in terms of ESG reporting, came from their investors who are typically institutional investors or family offices. As a result, we typically see three areas of major divergence between the ESG approaches in private and public markets:

First, private companies have rapid growth as a priority can overlook the importance of ESG and often focus their resources on what they perceive as financial priorities versus sustainability concerns. Their growth is attractive to investors in the private markets who have well-defined ideas on the investment hold period before they enter a transaction. Rightly or wrongly, this can mean that factors that on the surface appear to be non-financial, such as ESG concerns, take a backseat.

Second, private company investors are naturally from a smaller pool in comparison to public market investors, who may be more representative of the general public’s sentiment on ESG issues. Importantly, such weighting given to ESG in public markets is also reflected in popular indices and ETFs that will only consider companies that are viewed as ESG performers. Private capital is catching up, and of course there are exceptions in the form of impact investors, but it is generally behind the public markets in the weight it applies to ESG.

Third, there is much more scrutiny and far greater expectations of transparency on non-financial reporting for public companies. Mandatory ESG disclosures are becoming commonplace, and there are now 24 stock exchanges mandating ESG disclosures for listing, encompassing over 16,000 listed companies worldwide. Regulators are also requiring more detailed ESG reporting from both listed and private companies and their investors, as the recent EU SFDR and Taxonomy Regulation affirm. Moreover, greater third party scrutiny of public companies from rating agencies, NGOs and the media is a given.

ESG evolution in the private markets

However, this landscape is evolving and rapidly. Not only are investors in private equity and credit funds asking for more information on ESG, but new pressures are emerging from regulators, employees and a growing sense of moral obligation to people and planet.

Significantly, all markets are also beginning to realize the connection between fiduciary duty and ESG. If ESG concerns are affecting exit valuations of privately held assets – be that at IPO or otherwise – then the direction of travel is becoming ever clearer and all private market investors will no doubt consider ESG as an indispensable element of any investment.

What can private market investors do to achieve a more successful exit?

In most cases, investing in the private markets is fundamentally an engagement between a company and only a handful of investors. These investors: a) often practice longer-term investment cycles; b) have direct links into the company’s management; and c) hold ideas from early on regarding how and when they want to exit the companies.

Such factors differentiate private investing from the public markets and can influence the ESG approach in that, ultimately, these investors can have a greater influence on the behavior of a company. In conjunction, they have a clear incentive to demonstrate ESG improvement in each portfolio company over the investment term to aim for a more successful exit.

We help our clients to understand what ESG data to collect, how to collect it and what to do with that data in order to achieve a better exit. At all stages of the investment cycle, we work with fund managers and their portfolio companies to ensure that they:

  • Report ESG data in-line with the expectations of stock exchanges, regulators and leading standards;
  • Benchmark their ESG performance against key frameworks and their sector peers;
  • Receive clear action plans and support to improve their ESG performance to enhance strengths and address weaknesses; and
  • Quantitatively track improvements in ESG performance over the investment term – demonstrating their value as companies and investors to wider stakeholders and prospective buyers.

When the time comes to exit, via IPO or otherwise, our clients are safe in the knowledge that they are already up-to-speed, if not ahead, of their competitors in terms of ESG reporting and can prove a historical growth trajectory in terms of ESG performance improvements over time to potential investors.

This blog was first published on Global Custodian on April 15, 2021.

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