As sustainability has become a much used buzzword across sectors and geographies, driven by increased consumer and investor awareness, regulators are prompted to increase transparency around sustainability reporting. Investors who conduct business in the EU face mandatory requirements to disclose the sustainability level of their investment products.
Such requirements are laid out by regulations including the SFDR. Under SFDR, if a VC or PE operating in the EU wants to market a “green” fund, it must build a fundamental understanding of the sustainability profile of its portfolio companies, including their alignment to the EU Taxonomy.
But it's not just a regulatory matter - many investors now conduct voluntary EU Taxonomy and sustainability assessments of their portfolio companies even when they are not obligated to do so. In these turbulent markets, it's clear that being “green” is a differentiator that can support capital flows.
As investors are going the extra step to conduct voluntary sustainability assessments and reporting of their impact, portfolio companies should be prepared for persistent pressure to build their ESG narrative.
However, many portfolio companies, particularly those in earlier stages of development, may not have the bandwidth or knowledge to implement key policies and develop sustainability KPI tracking systems.
As a result, collecting this information can be particularly challenging for investors. As current corporate level disclosure regulations, including the CSRD, normally do not apply to SMEs and start-ups, investors are far too often left scrambling to collect the relevant ESG data to ensure they are complying with the investor level disclosure regulations.
But these new rules also constitute an immense opportunity for SMEs and start-ups: by aligning with the existing sustainability regulations, such as the EU Taxonomy, they can increase their appeal to investors and secure funding for future growth. They can also get a head start on managing ESG-related risks, which will position them for future growth and success. ESG integration is fast becoming a norm in the investment community, and young companies looking to fundraise should be aware early on.
In this article, we go through what EU Taxonomy reporting means for SMEs and start-ups, including some of the specific challenges faced by these businesses, but we also shed light on the opportunities that lie ahead for small companies that embark on their reporting journey early on.
A report by the European Banking Federation (EBF) highlights that one of the main challenges facing the application of the EU Taxonomy to SMEs is the lack of data required to assess the Technical Screening Criteria (TSC) for substantial contribution and ‘do no significant harm’ (DNSH).
Large corporations typically have the resources and personnel necessary to implement robust sustainability management systems, while SMEs often do not.
With the increasing number of ESG reporting frameworks and regulations, this disparity continues to grow. Sustainability reporting and transparency should be seen as an opportunity for SMEs to strengthen their business and increase appeal to potential investors.
Further, large corporations facing their own sustainability pressures are turning to their supply chain and requiring the smaller firms that they do business with to implement certain ESG safeguard policies and to report on their sustainability impacts. Whether its customers or investors, bringing cash into the business may come with certain ESG requirements that firms should be prepared to address.
By proactively implementing data collection and management systems for sustainability, SMEs can gain a competitive advantage and differentiate themselves in the market, securing stronger funding and boosting reputation among stakeholders. Those who act early and become leaders will be well-positioned for the increasing regulatory requirements and investor demands over the next decade.
While these frameworks are daunting, start-ups can have a big advantage over larger more established firms when it comes to the EU Taxonomy.
In fact, it is easier to embed the required EU Taxonomy TSCs into a firm at the early stages and infusing sustainability into its business model, principles, and culture, from the beginning rather than trying to bolt them on later as regulations and investor expectations change.
As investors are mandated to report on their exposure to sustainability indicators, they are looking for firms that can provide the necessary data and implement the required policies. By having the required data readily available, firms can increase their attractiveness to investors and be prepared for eventual data requests.
There is already evidence that VCs reward startups that incorporate ESG policies into their business. According to the report published by KfW and BCG, startups with strong ESG performance received a 19% higher valuation compared to companies that perform at an average level.
However, despite clear evidence that investors value ESG indicators when assessing companies, many start-ups are still lagging when it comes to implementing policies.
A survey conducted by KfW and BCG revealed that only a small percentage of startups have established policies and procedures to systematically integrate ESG into their operations. This indicates a disconnect between investor expectations and the ability for smaller firms to perform. Therefore, start-ups aiming to raise capital can stand out and attract investors by aligning themselves with existing ESG regulations, including the EU Taxonomy.
Of course, start-ups and SMEs often have limited time and resources to dedicate to the collection and analysis of ESG and financial data.
Luckily, there are a growing number of technological solutions on the market that can greatly reduce their data collection and analysis overhead. At Briink, we built NLP-powered tools that can assess large amounts of unstructured data and help you collect ESG indicators collaboratively across stakeholders.
Our digital reporting platform allows VCs and PEs to simplify their SFDR reporting process by breaking down the regulation in manageable steps, and helping them monitor more portfolio companies at the same time.
If you are a small company, a start-up or investor and you are still unsure of whether you will need to perform these assessments, we encourage you to request a consultation with our sustainable finance experts. It’s completely free and you can book it with just a few clicks.
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