Environmental, Social and Governance (ESG) factors are not the latest business thinking fad. It is fact that today’s investors increasingly want to invest in sustainable businesses with good investment models and integrating ESG factors will set you on the journey that your investors will be wanting to see evidence of – and importantly this will increasingly include all providers of finance into your business be it a bank loan, direct investment or an equity finance arrangement. But does this hold just for large corporations?
Let us first understand what we are speaking about, when mentioning ESG:
- Environmental – measuring your environmental data and thinking of ways to cut energy, water and waste usage. So you are both on a cost saving exercise and an environmental one.
- Social – this will certainly help you in today’s war for skills and talent. Having an attractive business culture will help you to maintain low staff turnover and will also attract more easily the bright talent you need to secure growth.
- Governance – focusing in on the governance of your business – and in particular devoting focus on risk management – will not only appeal to all your stakeholders. Good risk management practices will also bring their own costs savings in various areas.
The regulatory momentum for ESG is gaining ground and speed. In March 2021, the EU introduced a green taxonomy for the financial sector. The Sustainable Finance Disclosure Regulation (SFDR) has made it mandatory for asset managers, Venture Capitalists private banks,and other financial institutions to disclose ESG credentials on their websites and in their annual and quarterly reports. Germany went a step further in May 2021, announcing that ESG reporting would become mandatory for all sectors as part of its new Sustainable Finance Strategy (SFS). The UK is making important strides in this area, too, becoming the first country in the world to make the Task Force on Climate-Related Financial Disclosures (TCFD) mandatory, as well as announcing plans to introduce its own ESG framework, largely in line with the European Union’s.
You might say, but what does this has to do with me as the owner of an SME or a small family business?
SMEs that can demonstrate their ESG commitments in hard numbers will have a competitive advantage. They gain greater access to capital, and will also be able to manage risk more effectively, minimising regulatory interventions that may slow down growth. ESG measures have also been shown to increase efficiencies, reduce costs and increase employee productivity. Furthermore, companies with strong sustainability policies are more likely to have a strong reputation and greater trust among partners and customers.
Having said so I fully understand that while their are compelling reasons for SMEs to look at ESG in a serious manner, they also have great challenges to be able to do so. Many times SMEs already have a great task to report on their financial performance, let alone on issues such as its carbon footprint or the transparency of its supply chain. Moreover, ESG reporting frameworks are fragmented and often complex with many SMEs finding them daunting to engage with. Many SMEs imply can’t afford to bring in an expensive consultancy firm or a team of data analysts. Overcoming these challenges is not impossible.This also means that if SMEs want to advance with ESG and they simply try to copy big companies then they will most probably fail. The reasons for this is twofold: on one hand they will invest a lot of energy and resources in doing ‘traditional’ ESG tasks such as writing ESG or sustainability reports. Secondly they will get very little in return from their stakeholders for these time consuming tasks.
So below are some insights for SMEs to consider to make sure they are not caught unprepared at some point in the future:
- Fix the basics: one mistake that SMEs can often make is to try to focus on sustainability trends they read about when they still having missing documented processes in their operations. Before thinking of introducing any greener product, first make sure that your internal operations are truly environmentally friendly or that you have basic safety procedures. These are the first thing your business partners will ask for, not any sustainability report, but if you have these basic policies in place, possibly backed by some certifications.
- Identify the sustainability issues that affect your business – The first step is to identify the ESG issues that impact your business. This should involve talking to your key stakeholders – customers, partners, employees and investors – and determining what issues are important to them. Fundamentally this is where the company establishes its values as a business and the sustainability issues that it is going to champion.
- Identify the relevant ESG benchmarks – Understanding what peers or similar companies are doing is always helpful. For SMEs benchmarks will most probably reveal that others are not very advanced with ESG either. However, it will probably also identify a few points where the peers are more advanced. Understanding these can prevent being left behind competition. Prepare benchmark and it will help you both in defining your ambition and drawing up next steps.While mandatory regulation on ESG is slowly being adopted, identifying relevant voluntary frameworks and matching their ESG priorities to best practice, SMEs can get ahead of the curve and take advantage of the head start they have against slower-moving competitors.
- Plan actions: Action plans are essential parts of strategies. Preparing an action plan the focus should be on the most important topics. This is especially relevant for small companies. For example social aspects are important. But if you only have a few employees then introducing a corporate volunteering program should probably not be your first action. You should rather focus on your products, to have a green value offering. Or get some certifications that your customers want. An action plan should not be long. Do not forget that ESG is about business. So your actions should have a positive impact and business benefit at the same time.
- Gather the data you need – In order to reduce the cost and resources required for data gathering, SMEs should do what they do best – find technology that overcomes the problem. In today’s digital world, nobody needs to face the pain of manual reporting – find a tool that automates the entire process for you.
- Report against your data – Transparency is a fundamental tenet of ESG. Customers, investors and the public are wary of companies that partake in “greenwashing” – laying claim to social good to boost brand reputation while not truly committing to sustainable business. Therefore, once SMEs begin gathering this data, they need to report against it and demonstrate an audit trail which validates that the data they are providing is accurate. However for SMEs writing hundred pages long reports does not make any sense. Honestly, it does not make sense for large companies either. You should still make sure to collect your basic non-financial performance data related to employees, environmental performance or suppliers. When selecting the indicators, use rather common sense and stakeholder expectations. External guidelines can give a good direction but can also give confusion with their dozens (if not hundreds) of indicators. Most of which are not relevant for SMEs anyway. Once you have your data it is great if you can summarize it in a few pages or on a website. This will increase the trust of your stakeholders.
The spotlight is slowly turning on SMEs to begin reporting on ESG, but those who begin the work now, and demonstrate their commitment to stakeholders gain a first-mover advantage. However, for this to happen SMEs need to make sure that they approach all this with the right mindset. ESG is not an administrative task. It is only credible if you walk the talk. ESG thinking must be incorporated in all the activities and decisions of your company. Leaders as well as employees should always ask if what they are doing is really sustainable? Or how it can be made more sustainable? Sustainability culture and ESG mindset can only come from the owners or from top managers and has to be cascaded down to all levels in the organization. Once ESG is taken seriously on all levels, performance improvement will follow too.
There is an opportunity for forward-looking entrepreneurs to lead on ESG while also improving the performance of their business – the time to start is now!