Private companies that fail to think long-term about ESG reporting risk losing out on funding opportunities. Andrea McAvoy explains why.

One of the advantages of a private company structure is greater autonomy over governance. Theoretically, private companies face a lighter burden of bureaucracy than their publicly listed peers, allowing them to be nimbler.

Nor do they have to cater to the demands of public shareholders increasingly focused on environmental, social and governance (ESG) factors.

Even without these external pressures, however, private companies need to start thinking carefully about their ESG strategy and what it will mean for their long-term future.

Times are changing and, in the past year alone, three separate developments have shunted ESG to the forefront of the SME agenda.

1. Regulatory changes

The assumption that only listed companies will be subject to increasing ESG regulation is outdated.

While ESG regulations introduced by the European Union, such as the Corporate Sustainability Reporting Directive (CSRD) and EU Taxonomy Regulation, will impact large private companies by 2023, their scope will expand to include all small- and medium-sized enterprises (SMEs) by 2026.

These new regulations will also have an indirect impact on SMEs, because they will influence their business relationships with listed customers and suppliers. The requirement for ESG data disclosures — in particular, climate-related information — will only continue to grow.

2. Funding requirements

ESG is now part of the lexicon of most private fund providers – from private equity to debt and beyond.

According to the Pitchbook 2021 Sustainable Investment Survey, 81 percent of general partners are either already evaluating ESG risk factors or will be focusing more on ESG risk factors in the near future.

The integrity and diligence of such pre-investment ESG reviews may vary. However, at a minimum, private companies should develop an ESG narrative to prevent excluding themselves from funding opportunities.

While most private equity (PE) firms include ESG as a non-financial risk for reviewing investment decisions, some also use it to help identify opportunities for value creation during the deal life cycle.

Ensuring that ESG is addressed in all forms, and integrated into a company’s long-term strategy, can help private companies maximise exit value, compete for capital against listed peers, and align with increasing listing requirements.

More than 50 percent of the global stock exchanges published ESG reporting guidance last year, compared to just 15 percent in 2015.

3. Commercial longevity

In a rapidly evolving world, where the operating landscape is adapting constantly to sudden events — emerging pandemics, climate disasters and social disruptions, for example — a focus on ESG could help SMEs mitigate future risk.

Developing a genuine ESG narrative can also support key stakeholder relationships with customers, employees, and communities.

Some elements of this narrative will be aligned with immediate outcomes (i.e., how short-term expense will impact the bottom line). Others will relate to the cost of capital or the ease of doing business over the long term.

Applying an ESG lens to business strategy can bring broader benefits, however, helping SMEs shift the strategic focus from short- to long-term value creation, measured not just by profit, but also by environmental and social value.

Andrea McEvoy is Climate Change and Sustainability Services Senior Manager at EY.