In recent years, ESG investing (sometimes called sustainable investing) has grown significantly in popularity. A form of impact investing, ESG refers to investors evaluating companies based on environmental, social, and governance (ESG) factors when making financial decisions.

Many investors are seeking an ethical approach to how they deploy their capital, and using the ESG investment evaluation framework can help achieve this. Historically, this framework has been applied primarily to publicly traded companies and mutual funds. However, the private markets, which include venture capital, private equity, and other non-publicly traded investments, have not been immune to this trend. Some private market investors are now seeking opportunities that not only offer the potential to meet investment goals, but also align with their values and promote sustainability.

MicroVentures has more on ESG investing, including what it is and how it’s caught on in the private equity space.

What Is ESG Investing?

ESG investing is a type of investment framework or strategy that uses environmental, social, and governance (“ESG”) factors to assess an investment’s positive or negative impact in one or more categories. An ESG score is meant to measure the long-term commitment of a company in one or more ESG categories. ESG factors include climate/environmental impact, working conditions, human rights, anti-bribery and corruption practices, regulatory compliance and regulations, corporate governance, and more.

Here’s how the main ESG factors break down:

• Environmental factors – carbon emissions, deforestation, pollution, green energy initiatives, water usage, etc.
• Social factors – employee diversity, fair labor practices, human rights, etc.
• Governance factors – lobbying, board member makeup, political donations, lawsuits, executive pay, etc.

Why ESG Investing Can Matter

ESG factors aren’t just about ethics—they can be used to evaluate the potential for material risks that could impact a company’s value. Should a company choose to ignore or minimize its commitment to ESG factors, it could possibly face serious costs that could impact its ability to achieve and/or sustain profits over the long term.

This type of investing matters for several reasons:

• Aligning Values: Many investors today want to put their money into ventures that reflect their values and beliefs. ESG investing may allow individuals to invest in companies that share their commitment to social and environmental responsibility.
• Impact: ESG investing has the potential to drive positive change in the world by directing capital towards companies with a mission to improve society and the environment.
• Addressing Environmental Challenges: Sustainable investing can contribute to addressing pressing environmental challenges, such as climate change, deforestation, and resource depletion. By directing capital toward environmentally responsible companies and projects, investors can help companies who have a goal to reduce the negative impacts on the planet.
• Promoting Social Equity: ESG investing can support companies that prioritize fair labor practices, diversity and inclusion, and community development. This helps promote social equity and may contribute to reducing disparities in income and well-being.
• Encouraging Ethical Business Practices: By investing in companies with strong governance and ethical standards, investors can incentivize businesses to maintain transparency, accountability, and responsible management practices.
• Financial Performance: McKinsey reports that numerous studies have shown a positive correlation between strong ESG performance and higher equity returns[1]. Investing in sustainable companies may provide an option to help an investor meet their long-term investment goals. However, past performance does not guarantee future results.

ESG Investing in Private Markets

While ESG investing is often associated with publicly traded stocks and bonds, it has also been gaining traction in the private markets. According to a report by Morningstar, ESG funds attracted $19.6 billion in 2024, up from from $13.3 billion in 2023.

This approach has become more mainstream, and potentially for good reason. According to a study out of the NYU Stern Center for Sustainable Business, over a longer time horizon, the implementation of sustainability initiatives at the corporate level has been correlated with improved operational efficiency, risk management, and innovation. Therefore, in addition to being a more ethical way of investing, there is some research to suggest that these criteria could possibly result in better financial performance over the long haul.

ESG investments can offer unique opportunities for sustainable investors.

• Venture Capital: Startups and early-stage companies can be a place for innovation and disruptive solutions to sustainability challenges. Investors in venture capital funds can back companies with innovative products and services aimed at solving environmental and social issues.
• Private Equity: Private equity investors can actively engage with portfolio companies to improve their ESG participation. By influencing business strategies, governance, and operational practices, private equity can play a role in driving positive change.
• Real Estate: Sustainable real estate investments focus on eco-friendly and energy-efficient buildings, as well as properties located in communities that prioritize sustainability. These investments can help deliver a positive environmental impact.
• Alternative Assets: Private market investors can diversify their ESG portfolios by considering alternative assets such as renewable energy projects, impact funds, and social enterprises.

Measuring ESG

ESG investing is a framework that is often applied to the public market. Measuring ESG factors for publicly traded companies and mutual funds is easier, as there is a lot of data available, making it easier to see how a company stacks up in these areas against its peers. When it comes to private companies, however, using these same criteria can be far more difficult. Not only are there fewer peers to compare to, but most startups will not have this data readily available.

In addition, there is no standardized set of ratings or scores that can be used to evaluate any public company, mutual funds, or privately held company. While private rating systems can be used, their implementation and results may vary to a significant degree. The data used may not be subjective, verifiable, or reliable, and various rating systems may weigh ESG factors differently.

Key Principles of ESG Investing for Private Investors

Because it can be difficult to measure ESG objectively, let’s delve into key principles that individual private investors may want to consider when evaluating these opportunities.

Define Your Goals and Values

The first step in ESG investing is to define your goals and values. What causes or issues are most important to you? Are you passionate about environmental sustainability, social justice, or corporate governance? Understanding your values can help you align your investments with what matters most to you.

Educate Yourself

Before making any investments, it can be important to educate yourself. This includes understanding ESG factors, the various approaches to sustainability, and the latest trends in the private markets. Many resources, such as books, online courses, and financial advisors, can help you in your research.

Evaluate ESG Factors

When assessing potential investments in the private markets, investors may consider looking at the company’s commitment to ESG factors. Analyze its environmental practices, social impact, and corporate governance. Consider factors like carbon footprint, workplace diversity, and ethical governance. This evaluation can help guide you toward businesses that align with your values.

Seek Impactful Opportunities

While financial returns can be considered a focus of investing, sustainable investors often seek opportunities that allow them to both meet their financial goals and be a part of positive social or environmental impact. Look for investments in companies and projects that have a clear and measurable commitment to making the world a better place.

Engage with Investment Managers

Private market investors often rely on investment managers to guide their investment decisions. Engage with your investment manager about your sustainability goals and preferences. Together, you can identify investments that align with your values that could potentially help meet your financial objectives.

Monitor and Measure Impact

ESG investors may want to regularly monitor and measure the impact of their investments. Understand the progress companies are making in achieving their sustainability goals in driving positive change.

Challenges and Considerations

While investing in private markets may offer many advantages, there are challenges and considerations that investors should be aware of:

• Limited Liquidity: Private market investments are illiquid and may require a long-term commitment. Investors should be prepared to lock up their capital for extended periods.
• Impact Measurement: Measuring the impact of private investments can be challenging. Investors may need to work closely with companies to ensure they meet their sustainability goals.
• Risk-Return Tradeoff: Achieving both financial growth and sustainability goals can be challenging. Private investors may want to carefully balance these objectives.

Final Thoughts

ESG investing offers an opportunity to align your financial goals with your values. As the world increasingly recognizes the importance of ESG factors, private investors can help companies drive positive change. By understanding the key principles of sustainable investing, defining your values, and actively engaging with investment managers, you can create a sustainable investment portfolio that reflects your ethics and aspirations.

Remember that sustainable investing is a dynamic field, and staying informed and adaptable can be important. As the private market landscape continues to evolve, so too could the opportunities for private investors.

Are you looking to invest in sustainable startups? Sign up for a MicroVentures account to start investing!

Want to learn more about ESG investing? Check out the following MicroVenture blogs to learn more:

• Sustainable Investing: Aligning Goals with Purpose
• Impact Investing 101
• Investment Strategies for Ethical Investing

 

[1] https://www.wolterskluwer.com/en/expert-insights/the-importance-of-esg-as-a-key-drive-of-corporate-performance#:~:text=According%20to%20McKinsey%2C%20studies%20show%20that%20strong%20ESG%20performance%20is%20positively%20correlated%20with%20higher%20equity%20returns%20and%20reduction%20in%20downside%20risk

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.