Ep 1 - Marc Lepere - ESG and VC

Introduction:

Welcome to ESG in VC. And thank you all for listening. I'm your host Oksana Stowe. This is the first episode of many more to come. And today we have Marc Lepere with us. Marc is currently researching the link between crisis and ESG at King's college. He's a fellow of the higher education academy and also serves as a visiting lecturer at Wharton business school.

Professionally, Marc has been an employee, social entrepreneur, and recently a founder. He has worked at various distinguished corporations in senior roles. Most recently he founded an exciting new start-up called ESGgen. He has lived in Dublin, London, Germany, France, and on both coasts of America. And on top of all of that, Marc is a keen sportsman. He is a lifelong fan of Munster Rugby and still competes internationally in Ireland’s Sabre Fencing team. 

Oksana: 

Hi, Marc. It's great to have you with us. I would like to start from the very beginning and ask when you knew that you wanted to dedicate your Ph.D. to ESG, and when you first started exploring this theme around ESG. 

Marc: 

Hi Oksana, Thank you very much for inviting me. I think it was about five years ago when I was studying for the Masters, and that was when I first started in ESG. I think the motivation really was inequality, which at the time I felt was as big an issue as the climate crisis and on a similar timeframe, but it wasn't getting anything like the same attention.

As a businessman, I think it's a huge issue for our version of capitalism, which is as we know, shareholder capitalism fundamentally.  I think it especially impacts the venture capital industry because VC acts as a kind of advanced score of shareholder capitalism if you like because it invests in early-stage companies before they come to the public stock markets.

If you think about the current model of VC, it's very much focused on high-growth innovation. So it's about the acquisition of users, revenue, and deepening engagement. It's really about speed to scale. When you look at the literature, the academic literature on how VC-backed companies perform in terms of responsibility and ESG, the finding is that they are slower to become more responsible over time than companies that have not been VC-backed. 

In other words, VC doesn't really seem to, at the moment anyway, foster really responsible businesses. I think this is primarily for two reasons. One is that traditional VCs, if you like, focus, as we know, on maximizing the value for the shareholders, for the investors and that's above really any other consideration for employees, customers, other stakeholders, society, etc. 

The second thing I think is the time frame mismatch. VCs have a very short or relatively short-term focus of three to seven years compared to the much longer-term horizons of ecological and environmental responsibility to give us some idea. I mean, if you think about an oak tree, just a single oak tree takes around 40 years to mature compared to a three to five-year timescale for a VC and an elm tree, just by way of comparison, which is one of the fastest growing trees still takes 12 years. So there's a real mismatch on time as well. 

So clearly there's work to do not just for the whole economy, but for VC in particular. That’s one of the main reasons I got involved in this is that if we're to mobilize start-up-led innovation and private finance as the engine of the future economy and the next generation of start-ups and founders, they need to start from a different place.

Oksana: 

I love that analogy around the trees. It's a great one actually. So my next question is why do you think ESG as a framework seems to be the one that is gaining the most attention and maybe even the most adoption given that there has been a number of frameworks out there that people have come up with over the last decade?

Marc: 

I think the short answer is not invented here. So if I just explain that a bit, you’re right that over the past, not just the last decade, but the past five decades really we've had, you know, a rough order of how they've come to the world. 

We've had the idea of corporate social responsibility or CSR. We've had the idea of a triple bottom line of people, planet, and profit. We've had the idea of shared value, the circular economy, which is still very much part of modern thinking. We've had the idea of corporate purpose. We've even had some academics suggest that public companies should be responsible for the provision of public goods and services where Marcets and governments are unable to provide them.

And then of course, more recently in 2015, we've had the Sustainable Development Goals from the UN. So you're right, there have been a lot of different frameworks and some of them are weakening in their penetration of thinking and others are growing and a lot of them still co-exist. 

So what is it about ESG that has really stuck? I think that's an interesting question. And I do think it comes down to the fact that, of all the other ones I mentioned, they haven't been invented by the investment community. Whereas ESG has. It has come from the investment world and it's basically a recognition that these considerations, environmental, social, and governance considerations, are material to company value and material in a 5 to 10 year time horizon.

Obviously like any new idea, you get some people resisting it, you get some people saying it's nonsense, but I think again, if you look at the academic literature and the best practice out there, there is an enormous and growing body of evidence to support the fact that ESG is material, especially in those time horizons, and it's something that people really do have to consider, not just for the management of risk, but for the purpose of growing successful businesses. 

Oksana: 

Great. And one of the themes as I was digging a little bit in your interviews and research that runs through your research is how artificial intelligence compounds ESG risks. Would you elaborate a little bit on this and why we should pay attention to it? 

Marc: 

Sure. I think the straightforward, simple answer is because artificial intelligence, machine learning autonomous systems, generally, they crippled decision-making in a crisis unless they're really, really understood. By that, I mean that if you take the 2008 market crash, well, not an example of autonomous systems, particularly, although there was quite a lot of automation involved, the idea of credit default swaps basically made risk so opaque that decision-makers were completely neutered at the time. And as we know, the world economy nearly crashed. 

I think the scale at which artificial intelligence, machine learning are making decisions in life, in all walks of life, and all companies without most of us knowing, and certainly without VCs or other investors knowing it, is really quite shocking. I think if we really knew the extent of the decision-making power and the scale of those decisions, most people would be quite surprised. But the truth is those decision-making, or that decision making is actually pretty opaque.

We don't really know how it happens. Most people have no idea what's in the stack i.e. the layers of software that go into their operating systems. And frankly, if you don't know what software your portfolio company for instance has bought, there's simply no way in a crisis of reverse engineering a decision on how to go back to where it all started from. The machine is learning itself, it runs away with you. If you don't know how it's thinking, you kind of reverse engineer it.

Frighteningly, although it's pretty much prevalent throughout virtually all walks of life, it's largely missing the idea of autonomous systems, AI systems, if you will, are largely missing from ESG frameworks. And that's not something that I think regulators are going to miss going forward. I think pretty soon, they're going to catch up with this notion and ask for and insist on some metrics around an understanding of what's in the stack as parts of an ESG report, for instance. 

Oksana: 

Great. And talking about the components of ESG, it seems that public and key players are very familiar with E as that sort of comes back to the previous question we discussed. There have been a lot of frameworks around impact, circular economy. How long do you think it will take to create the same awareness around S and G? And what are the dangers of paying less attention to the other two factors? 

Marc: 

As you say, it's understandable in a way, I mean, Cop26 is on right now and clearly, there's been a lot of activism around the environmental side of things. It's more obvious in many ways, therefore, because there’s more activism and more people are engaged with it, it's more politically potent. So it's understandable. 

But it's a good point that you raise, I think to try and separate the S and G components is misguided. And again, the literature is pretty clear on this. The risks to VC are actually increased if you try and separate the component pieces out. Elinor Ostrom, I don't know if that name rings a bell, but she was the first woman to win the Nobel prize for economics. Her book was called Governing the Commons. And she very clearly sets out how the way we think about the E, the environmental piece, is entirely a function of how we manage the societal piece and the economy.

For instance, we could easily have carbon pricing. We could have had it 20 years ago if the world agreed on it. Another example that I think really helps to bring the linkage between the E the S and the G, but particularly this case between the E and the S is actually pandemics a bit like COVID-19 my colleagues at Kings tell me that as climate change worsens, one of the things that we lose is habitat. Loss of habitat means that animals and people are forced closer together, probably where they ought not to be. And when that happens, viruses that are not meant to be, either the animal or the person, jumped from one to the other. That is a huge source of pandemics. So if you try and pretend that these things can be separated, they really can't be. As an example, climate change will drive almost inevitably future pandemics. 

So I think that's quite a good illustration of it. I think in terms of people paying less attention to the S, I think again, COVID actually helped a lot. 

I think a lot of people recognized the role of key workers in the economy and recognized that actually, those jobs are hugely undervalued and underpaid. Most of the less well-off workers in society, less well-paid workers are in fact, the key workers that we all depended on. And I think a lot of people at an individual level have viscerally seen that and viscerally feel that.

I think it's interesting, you're seeing now huge numbers, I read the other day about a quarter of employees are expected to be either resigning or not returning to work in the next 2, 3, 4, or 6 months. And that might be an indication really that better wages, better treatment of workers is necessary. 

So I think the recognition of the S has been accelerated massively by COVID. But in any case, let's say it's a real mistake to try and break the components apart. 

Oksana: 

So you’re actually founder yourself and coming back to the public awareness, you as a founder of ESGgen, which is a platform that helps SMEs and start-ups to start measuring and auditing their ESG data very early on. What is your feeling? Do founders understand all three aspects of ESG and are venture funds doing enough to encourage ESG accountability among their portfolio companies? 

Marc:

It's a very interesting question. I think I would say that there are three mindsets, if you like of the people that we speak to or the VCs that we're speaking to. There are definitely some people let's call them the progressives. They are people who get it. They see the point of ESG. They see the fact that it both creates value as well as it is value at risk if you will. But to be honest, they are relatively few in number I would say, as of now. 

The second mindset that we see a lot of is what I call the compliance mindset. These are guys who either resist the notion of ESG or more typically just don't really believe yet that it really, really matters in the grand scheme of things. They’re not saying that it's not important, but they’re saying that given the priority of financials or that it just isn't as important. I say that that's a very large minority of the people we speak to. I don't think it's a majority, probably just under.

The third mindset that we encounter is what I call the CSR mindset. So that goes back to a corporate social responsibility mindset. That kind of looks at ESG in a similar way that people consider CSR. It's basically a Marketing exercise. And I would say that that group is just about a majority of people. And again, if we go back to the literature, what do we know here? What does the world know about this?

We know is that actually, progressive VC, which builds ESG into companies, right from the beginning, they actually do turn out to be more responsible than traditional money-focused, purely short-term focused shareholder value-focused traditional VC-backed companies, if you will. So there really is a chance for VC to develop companies that have, if you like responsibility built into them from the very beginning rather than trying to bolt it on after the fact when they've gone onto a public stock market. 

I think that finding in the literature that that is real, that VC can make a real difference, right from the beginning. I think that's really exciting and obviously critical if we're going to meet the challenges of climate and inequality. 

Oksana: 

Understood. All very, very good observations. My last question before we wrap up could be ESG-related, could be not ESG-related. What surprised you the most in the last few months and why? 

Marc: 

Well, I better stay focused on ESG. So let me do that. I would say two things, to be honest, the first is actually this idea of the CSR mindset, which I mentioned just now. And I'll come back to that. 

The second one is the apparent slowness of the VC industry, if we call it an industry, to grasp the opportunity that ESG presents. So let me just touch on those each in turn. 

So if we go back to the CSR mindset, this idea that somehow the ESG is just another marketing exercise. I think there is a fundamental difference that's alluding people, and that is that ESG has always had the idea of reporting or companies disclosing their performance at its heart. Now until 2018, that reporting was always voluntary and companies could basically say what they like and they could cherry-pick, they could decide to emit information that they didn't think was favorable or set the company up in a favorable way.

Hence they applied the same kind of thinking as they applied to CSR. And as a result, we've got lots and lots of greenwashing going on, if one is being frank. However, that's all changed, particularly in Europe. And it will change in Britain. The other day, a government white paper just last week, made it very clear that the regulators have decided to adopt ESG has a mechanism if you will. They're making it compulsory for companies to report on this stuff. 

So the real difference is if in CSR you could choose what you wanted to talk about, in ESG you can't because there's regulation in the EU taxonomy. For instance, there are 21 metrics that you absolutely have to report to if you're a financial services company. Okay, that's not negotiable. That is a de facto standard. 

The second thing I think that's interesting in that context is the idea that regulators in the world can allow companies cherry pick, if you will. No, I think I'll talk about these, but ignore that. Or I'll give myself a really easy target for the next 15 years because I think it'll make a good Marketing story or a VC thinks it'll sound good to their LPs for instance. 

I think that's going to be over time, less and less acceptable. And in fact, targets and benchmarks will be based on the scientific best available evidence. And we're seeing, I hope some of this going to be unearthed and surfaced at COP26 this week. 

And then the last point is given the greenwashing problem and the prevalence of greenwashing, regulators are also actually pointing it out in the regulation. They're saying we are listing these particular metrics that companies have to report on because we are trying to stamp out greenwashing. They explicitly stated that. So that means in my opinion, and a lot of people support this idea, that very quickly that ESG and disclosures and reports, that there will be a requirement to have them audited or, you know, in the technical language of auditors that it's an assured product, but essentially it’s audited, just like you would any financial and material data. 

I think this CSR mindset is misleading and confusing and actually not really serving VCs or their portfolio companies very well because it flies in the face of the regulation that they're required to do and auditing that’s almost certainly around the corner. 

The second big surprise, I guess, is that most people are not more excited about the huge opportunity, and the huge capital growth opportunity that ESG represents. I mean if you think of re-engineering the world's economy and its infrastructure, it's quite possibly the biggest new business, let's call it an opportunity, that the world has ever seen. 

I think it's starting and there is an entrepreneurial spirit. You can feel it in some of the conversations we're having. But with the right incentives from policymakers, and that's going to be crucial, but combined with the inventiveness of the VC industry, hopefully, it won't be too long before we are growing the businesses of tomorrow, that as I say, are starting in the right way, in other words, responsibilities, of how they think of their business models or the way they think about the world and their place in it, rather than going, let’s just go for absolute growth, pretty much forget everything else and then trying to become good later on.

I think that model is not going to survive. I think that VC will adapt. And I think that's exciting. 

Oksana: 

Very well said. I also believe that the future is bright. Thank you so much, Marc for your time and for all the great insights and have a good day. 

Marc: 

Thanks very much, Oksana. Thanks for inviting me. 

Oksana: 

I'm Oksana Stowe, and you have been listening to ESG in VC podcast. You can follow ESG in VC on LinkedIn, Instagram, or Twitter. If you haven't yet, you can also subscribe to our newsletter. Thank you for listening.