This article is sponsored by Permira
It is a decade since Permira launched its first environmental, social and governance framework. The firm’s stated objective back then was to galvanise a more consistent approach to addressing ESG-related risks and opportunities during the investment process and to link this approach to value creation. We caught up with Adinah Shackleton, who joined the GP in 2015 as its first head of ESG, to ask how Permira’s approach to responsible investing had evolved since then.
Over the past decade, what’s changed in how Permira addresses ESG?
The ESG agenda has broadened in terms of topics, focus and LP, stakeholder and portfolio company expectations. Previously there was more focus on due diligence followed by the post-investment review of companies. Since 2010, deal teams have become increasingly thoughtful about the short-term and long-term ESG issues that could be material to a business.
One of the first things that I focused on is how we could monitor ESG more consistently across the portfolio and obtain data from companies around priority ESG areas. Monitoring and reporting get a lot more attention.
In terms of topics, 10 years ago the focus in due diligence was on environmental risks and liabilities, health and safety, and governance. Today, topics encompass areas like responsible marketing practices and human rights in the supply chain, which are really front of mind for some companies.
Cybersecurity has risen up the ESG agenda and there’s a recognition that this is a real risk to business. We’ve worked on how we ask deal teams to look at this during the investment process and engage with portfolio companies post-close.
Diversity and inclusion also cuts across the portfolio. It’s something portfolio companies are very interested in: how diverse teams can make better decisions and be more successful financially. And there is significantly more focus on climate change. The level of public dialogue around this topic has really increased.
What impact has this broadening agenda had on the due diligence process?
Historically, ESG was more focused within the boundary of the business. Now when teams conduct due diligence they take a wider perspective on the impacts, risks and opportunities that a company might be exposed to – whether that’s through the supply chain, products or services, for instance. That has been a key change.
There’s increasing awareness around the impact of poor practice on an investment in terms of reputation, customers and revenues. Deal teams see that companies that manage these issues well can be more successful over the longer term.
Teams are also more aware of how ESG plays into the exit story.
Buyers want to see that ESG issues have been addressed effectively – for example, that an apparel company has a well-managed supply chain that has a proactive approach to mitigating labour and working conditions risks.
“We receive investor questions on ESG from a much broader range of jurisdictions, not just LPs in Europe”
At exit, what kinds of ESG-related questions do buyers ask?
It varies depending on the sector and the nature of the buyer. A trade buyer making an add-on acquisition is often interested in the culture of a business and how well aligned it is with its own ESG compliance and business practices.
We saw this with Magento, an e-commerce platform we sold to Adobe.
Adobe was very focused on ESG during the due diligence, and people-related issues were important to it. It wanted to invest in a business that could slot in beside its existing business culture. Magento had spent a lot of time focusing on its diversity and inclusion strategy, including at a senior management level, as part of its focus on its values and culture.
And what are LPs’ ESG priorities?
Today we receive investor questions on ESG from a much broader range of jurisdictions, not just LPs in Europe. Some LPs are shifting from a high-level questionnaire approach to showing increased interest in ESG performance at the underlying portfolio companies.
Increasingly, LPs have their own responsible investment teams, and go beyond asking whether there is an ESG policy at the GP level to asking whether our monitoring teams really understand how ESG matters are managed on the ground. That’s a trend.
In terms of monitoring, how do you handle the volume and variety of ESG information that companies generate across different sectors?
It’s a challenge. There are a huge number of different and relevant factors that you could monitor. We have taken a two-tiered approach and integrate ESG into the monitoring platform that we use for portfolio company financial data.
At the portfolio level, we use a set of core KPIs that we believe are relevant across all businesses regardless of sector. We also ask companies to agree and report tailored indicators specific to the company. For a food and drinks business, a key topic might be food safety; for another, it might be energy efficiency. Ultimately, we want companies to report these indicators to their boards for action, so the reporting to us is almost secondary.
How do you evaluate ESG performance?
It’s very much integrated into how we evaluate portfolio companies’ performance overall.
We hold six-monthly portfolio review committees, which include evaluation of ESG progress. It’s a chance for us and our companies to reflect on ESG improvement areas included in their value-creation plans. We also highlight and discuss what more needs to be done to ensure management teams progress areas in which improvement has been slow.
For some companies – for example, one with a higher ESG risk or opportunity exposure – we also do visits to sites or operations during the hold period to see how ESG is managed on the ground.
Are there specific ways that businesses demonstrate the link between good ESG practices and value creation?
Definitely. For each company it’s going to be different. For instance, one of our portfolio companies benefits from significant tax rebates for meeting agreed energy efficiency targets. That directly impacts the business, which has invested in energy managers and energy efficiency measures to help achieve those savings over time.
One portfolio company, a data centre business in South Africa, started off small in terms of generating solar energy through installations on its roof. That has increased over time and it’s now looking to reduce its demand on the grid.
We’re also working with a business to put a value on health and safety initiatives. Reducing incidents and accidents over time leads to operational improvements and better employee safety, but also reduces compensation claims.
With some other areas – around supply chain improvements, for example – it’s harder to put a number against it. Although it’s harder to value in financial terms, it is clear that companies that focus on this can avoid crisis situations and reputational risk. It can also add to brand value.
“There’s increasing awareness around the impact of poor practice on an investment in terms of reputation, customers and revenues”
What kinds of challenges do you encounter implementing ESG best practice at the company level?
Initially, the team can be one of the biggest. At due diligence, a company might not have the right people or structure in place to manage ESG effectively. This is particularly the case with businesses in emerging markets.
Often as part of the value creation plan we set targets around building the team, whether that’s putting someone in place around health and safety, environment and quality control, or getting the chief operating officer to be really involved in the ESG agenda and topics. When the right team is on board, you can really start to see improvements in practices and performance.
For a company new to ESG, another priority is to ensure the business is legally compliant. Once you have a strong baseline in place, you can move the discussion on to ESG opportunities. It can take some time to truly embed ESG in a business.
Historically, buy-in for the business case might have been an issue. I feel like that’s becoming less of a challenge, and when we speak to companies around ESG and sustainability there is much more awareness and receptiveness to the value that this can bring. Management teams want to make sure they are not left behind as other businesses and customers are increasingly focused on these areas.
Management teams do recognise the connection between ESG topics, supply chain, products, reputation and crisis management and the impact that this can have on a company, its stakeholders, talent retention, customers and revenue.
Global warming is an increasingly urgent issue. How are you responding?
Public dialogue on climate change has really increased. Within management teams, we see a mixed level of understanding about the short-, medium- and longer-term impacts of climate change. We have been raising awareness through webinars and have engaged with portfolio companies to better understand the risk and understand which companies are more likely to be exposed. We also ask portfolio companies to report their carbon footprint and focus on energy efficiency measures, particularly for high energy consumers.
In terms of investment, we are seeing more opportunities for companies that help with adaptation and the transition from fossil fuels.
One of our teams looked at an electric batteries manufacturing company. This tied into the transition away from diesel- and petrol-based transport. Aside from this opportunity there were other issues to consider for the sector, including emissions from the production of new cars and human rights considerations in the supply chain linked to the use of cobalt in batteries. It’s never one-dimensional.
We recognise that more needs to be done to develop our approach to climate change and this is one of our key focus areas.
How do you keep up with a fast-evolving ESG agenda?
As investors, it’s important to be aware of how the conversation around ESG is changing and to ensure we’re reflecting on our processes and whether our approach remains fit for purpose.
The same applies to portfolio companies. They can’t stand still. New issues and different perspectives on ESG are going to continue to emerge, and companies will have to keep track of these changes.
One way we’ve done this over the last couple of years is by integrating ESG topics into our portfolio company conferences. We hold conferences for different roles in portfolio companies. At the last leadership conference, for CEOs and chairmen, three portfolio company CEOs talked about their experiences of ESG and how they integrate best practice into their overall business strategies.
These included the CEOs of German chemical manufacturer CABB, where process safety and health and safety are really front of mind; UK footwear business Dr Martens, which has integrated sustainability in its overall business strategy; and Duff & Phelps, a US-based valuation and business services provider.
We also used these sessions to address crisis management on topics such as #MeToo and cyberattack scenarios. These meetings are an opportunity for us to talk about our expectations and for portfolio companies to share and learn from one another.