L Catterton on how ESG can drive returns

This article is sponsored by L Catterton

As a global consumer-focused private equity firm, L Catterton has invested in more than 200 businesses and brands around the world over the past three decades. With many customers increasingly concerned about the quality and provenance of the products they are buying, the firm is uncovering a growing number of companies and brands around the world driven by responsible and sustainable ideas.

Dennis Ever, partner and head of global investor relations at L Catterton, explains how private equity can identify investments and add real value to businesses by using ESG criteria and processes.

Before joining L Catterton, you were at AlpInvest when responsible investing started to become a hot industry topic. How have you seen ESG develop and evolve?

Early in the 2000s there was a push among limited partners to spend time on the core backbone for ESG – environment, social issues and corporate responsibility. It was a big initiative at AlpInvest and its backers, APG and PGGM. I strongly believed that these elements were important and that they would become even more important over time. In the mid-2000s, the movement started to pick up steam. More LPs came on board and you had the creation and growth of ILPA and the UN-backed Principles for Responsible Investment.

The process was initially one of education and building awareness among general partners, focusing on engagement post-investment – best practice at companies, implementing standards, identifying and managing any ESG issues. Then the debate moved to due diligence at the front end and how to use ESG to create value at portfolio companies. LPs always had in mind that ESG factors would be important for value creation and driving returns.

For their part, GPs routinely considered these ideas – “are we working with companies and people in an ethical and responsible way?” But they increasingly embedded this thinking into their processes. A lot of GPs were open to LPs’ ideas and were engaged in the process. They started working with companies on responsible investment topics and they spent time actively trying to figure out how to bring ESG into investment processes.

How have you embedded ESG processes at L Catterton?
Our ESG policy starts at the top. L Catterton’s leadership team is very focused on ESG, and we make firm-wide decisions with an ESG mindset. Our global headquarters in Greenwich, Connecticut, was built to LEED Platinum standard and across our 17 offices we have a commitment to reduce our environmental impact. Our real estate business has achieved LEED Gold or the equivalent for its development projects. It is very important for us as a firm, both internally and externally, to demonstrate our commitment to the highest sustainability standards. We are also very focused on diversity – roughly half of new hires are female, and we have a representative body for women at the firm internally.

At an investor level, where we can partner with LPs on initiatives important to them, we do. For example, we are a signatory to the UN PRI and we have pursued best practices on ESG reporting, including those established by the ILPA guidelines.

From an investment perspective, we have also made a lot of progress. We bring in third-party ESG experts to help us conduct our due diligence around the globe. Founders/entrepreneurs and management teams are focused on the importance and impact of ESG and we partner with them on strategies that enhance ESG and drive value.

We have a global ESG committee that includes professionals from each strategy and business unit and have adopted an annual ESG questionnaire for each portfolio company to report on metrics like job creation, diversity, environmental management and CSR policies.

“The global consumer industry presents a lot of ESG opportunities”

You talk about the role of ESG in value creation. How has that influenced the way you think about investments in the consumer sphere?
One of the biggest things for us has been putting ESG at the core of our investment themes. As we research high-growth consumer categories, ESG is an increasing source of value creation and a significant part of our investment thesis that we are factoring in and seeing driving trends. We are considering ESG criteria during due diligence, and we are looking at ways of creating value using ESG initiatives.

The global consumer industry presents a lot of ESG opportunities. As a category investor first and foremost, we have seen a lot of changes in consumer behaviour and attitudes. Millennials and Gen Z really care about what they buy, where it comes from, how it’s made, and what impact it is having. There are a growing number of important themes that we have pursued, such as By Women for Women, Clean Beauty, Better for Baby, Sustainability and Authentic Heritage.

ESG is also important for people we bring into the firm and the companies we invest in. New hires want to join a firm that truly focuses on responsible investing.

What’s the practical impact on investment decision-making and strategic planning?
During due diligence, we have walked away from companies that may have had great return profiles but where we couldn’t get comfortable with issues like the supply chain. And when we do invest, the right ESG actions help to deliver value. At Honest Co – a digitally native, clean beauty company – the aim is to deliver safe, natural products for the family. It’s a fast-growing segment and ESG helps us make sure we are plussing up the benefits of the better-for-you positioning.

We’ve always had an active, operationally intensive investment model, which allows us to work in partnership with the founders/entrepreneurs and management teams on the important value drivers including ESG initiatives. Our dedicated operating team includes professionals with deep functional expertise in areas that matter most to these fast-growing consumer brands. They work with our companies on everything from digital marketing to supply chain.

How does ESG play into value creation at the exit?
We work hard to make sure companies are well positioned for the buyer – in our case the majority of our exits are to strategics or to the public markets. If ESG is important to our investors, and important to us, then it’s also important to the next buyer. So, it becomes a critical piece of maximising value.

For all the areas where we can tangibly measure ESG impact, we do. We know it’s creating value and driving better returns in many ways and we have KPIs we can use to show the impact of ESG. As an industry, there is increasing alignment on the importance of ESG on investment returns and we are moving towards ways of analysing and measuring ESG.

How do you see consumer attention on topics such as sustainability and ethical practices?
ESG issues are already extremely important to the consumer and we think they will only become more important over time. Big businesses need to embrace ESG topics if they are to succeed. At the same time, brands and companies in niches can get to scale very quickly by meeting the demands of environmentally and ethically minded consumers.

In today’s environment, investors care about what they are investing in, entrepreneurs care about what they create, and consumers care a lot about what they purchase. We want to ensure we are building brands that meet customer expectations and drive loyalty, while also having a positive social impact.

This is a global phenomenon. We see it across all the geographies we invest in – in emerging markets as well as developed markets. For example, FabIndia has had a lot of recognition for its work in local Indian communities, and Espaçolaser’s by-women-for-women story is resonating strongly in Brazil.

Where do you think the future will be for ESG?
I think in 10 or 15 years, ESG will be so engrained in what we do at private equity firms and in portfolio companies that the actual terminology will start to disappear. ESG is becoming embedded in everything we do – the investment processes, company management and reporting – and in the future everyone will be doing it. The fundamental ideas of ESG will be so central to value creation, that it will simply be value creation.

How are social considerations driving investment decisions in emerging markets?
Espaçolaser sits at the centre of a number of trends we have been following: wellness and beauty; shifting gender norms; and ‘by women for women’. The company is the largest laser hair removal group in the world and has a key focus on bringing women into the workforce and management roles. Some 96 percent of employees are women and 400 women hold leadership roles, including senior management. The company has trained about 3,000 women from across Brazil, including those from minority groups, and spends about $250,000 a year on childcare to help retain staff.

What do these kinds of initiatives mean to consumers?
Consumers in emerging markets respond really well to brands that have a social message. FabIndia is one of India’s most iconic artisanal brands. Its products are sourced from villages across the country and give work to 40,000 craftspeople, again many of whom are women in rural communities, and help keep traditional weaving and dyeing techniques alive. We introduced a number of initiatives to drive sales – for instance, the creation of a new sub-brand to reach a younger, more fashion-conscious consumer, and we made a strategic investment in Organic India, a leading producer of organic food and supplements. The result was that FabIndia was able to more than double revenues during our four-year investment and was recognised by the Bill & Melinda Gates Foundation for its impact.

What kinds of responsible issues are consumers focusing on in developed markets?
Plastics and packaging are a very big issue for consumers. The growth in ecommerce means that fashion retailers are generating and sending a lot of packaging. Last year, Danish fashion group Ganni signed up to the Sustainable Apparel Coalition and started a collaboration with Finnish sustainable packing firm RePack. Customers can choose to have their purchases delivered in RePack’s reusable packaging, which can be used again for 20 times or more. The company also has a programme to recycle used clothes and has been experimenting with clothing rental to make customers think about how they consume fashion.

What other ideas are important?
Provenance is a critical consideration when it comes to quality. Last year we invested in Boll & Branch, a direct-to-consumer maker of luxury bed linens and home products. The company’s mission is to be better for people, the planet and the consumer. Core to this mission is a supply chain where farmers and factory workers earn a real living wage, where there is no forced or child labour, and which requires equal treatment of women. The raw ingredients are made without chemicals, pesticides and GMOs, and are all done with sustainable waste and water treatment.