Middle East Advisory Partners is an Owner-Managed, SME focused bespoke advisory firm bringing top-tier advisory capability to the SME sector.
This is another in a series of Thought Leadership pieces addressing topics that are relevant to the owner-managed segment.
In this article we discuss the importance of a strong ESG strategy and how this can add value, not only in large corporate organisations, but also in private, owner-managed businesses and SME’s. We also discuss the critical factors involved in developing a strong ESG strategy.
An Introduction to ESG
Background
Environmental, Social and Governance (ESG) is a topical issue, but can sometimes be considered to a fad. However, studies show that an effective ESG strategy can support a company’s long-term performance and its ability to scale efficiently, both locally and internationally. ESG is also considered as an enabler to the long-term resilience of a business and as an effective value creation tool by developing financial interest and facilitating better exits. ESG represents a more stakeholder-centric approach to doing business and, although similar to corporate social responsibility, has a broader and more measurable application. The key ESG elements can be summarised as follows:
Environmental
Every business uses energy, water, resources and produces waste. Therefore, every company produces carbon emissions and impacts climate change, ultimately having an impact on the planet and the beings living on it.
Social
Encompasses the relationships a business has and the reputation it fosters with people both in the business itself and the community it operates in. This includes employee engagement, wellbeing, diversity and inclusion and drives businesses to measure and disclose more information on social factors.
Governance
The system by which business entities are directed and controlled. This can include internal controls, procedures, and measures that a company adopts to govern itself, make effective decisions, comply with local laws, and meet the needs of external stakeholders. Every company requires governance to a greater or lesser extent.
Value Creation
Companies that are at the forefront addressing their ESG strategy and ethos are generating more attention across the business spectrum, and investors are increasingly looking for companies with a strong ESG profile - often referred to as ESG Integration - sometimes refusing to invest in companies whose ESG values do not align with theirs.
Net zero, diversity and inclusion as well as climate risk all feature highly, especially with VC’s and as such are important considerations for any start-ups and SME’s considering a future exit. Company valuations have become more complex, with a growing proportion tied up in intangible assets. ESG metrics provide insights into the intangible assets, such as brand value and reputation, by measuring and documenting decisions taken by company management that impact operational efficiency, future strategic directions and the attraction and retention of the best talent.
This latter point is often not associated with ESG, but in a competitive job market where businesses are competing for the best talent, a strong ESG profile will be a differentiator for these soughtafter individuals when making career decisions. Young people especially, want to work for an organisation that not only has clear plans to scale and grow profitably, but also cares about diversity and inclusion, the impact the business has on the environment and a social responsibility to be compliant and support the communities in which it does business. ESG helps provide a clarity of purpose to the business and its employees, who in turn respond to this sense of purpose through increased motivation, productivity, and innovation.
Value can also be delivered though environmental improvements, which can result in the consumption of less carbon and water. A reduction in all wastes inclu ing energy, water, packaging, and production waste can also result in a reduction in disposal costs and pollution penalties, all of which ultimately lead to a reduction in operating costs. Decisions to invest in more sustainable equipment, with longer asset lives have a positive impact on a business’s carbon footprint, operating costs and is relatively easy to measure and demonstrate.
Customer attraction and retention is likely to be enhanced as the business focusses more on sustainability. This will have a positive impact on top line growth as both B2B and B2C customers increasingly prefer to buy from sustainable businesses, and this can be in the form of products and practices. In fact, recent studies have shown that many will pay a premium for a more sustainable offering.
Effective governance ensures that businesses remain on the right side of local regulations and that stakeholders are trained on compliance and similar aspects. Improved relations with governments and the local community can create value by avoiding potential costs associated with regulatory and legal interventions, poor labour relations and the resulting risk of shutdowns, strikes and a demotivated workforce.
In summary, a strong, integrated ESG strategy creates value in many ways, not only in large corporate organisations, but also in private, owner-managed businesses and SME’s.
Performing Your As-Is Assessment
An “as-is” ESG assessment provides the necessary benchmark from which to create your ESG goals and plan. It will identify, within the context of the key areas described above, where your strengths and weaknesses lie and where your business needs to focus efforts.
Starting a change program by first understanding the current position of the business is simple in concept but can be difficult to execute in practice. Very often a business is aware of the key elements of ESG, but the lack of an overall plan, with time-based goals, often results in a scattergun approach with difficult to assess outputs.
It can also be difficult to look at your business objectively, from the perspective of employees, government, potential investors, customers and suppliers, so having an open mind and taking a holistic approach is a key first step.
To be effective and to ensure an accurate baseline is developed, the assessment and report must be a frank and honest overview of current state. Try to include the actual position, rather than what you hope is happening. Utilising a third party to carry out this assessment and create the report should be considered to ensure impartiality and to improve auditability.
Developing Your ESG Goals
Moving forward ESG must be a priority for all businesses and will not succeed if Leadership is not fully engaged. The elements need to become interwoven across all departments and become part of the DNA.
ESG goals will be different across every business and depend on the type of business, and the industry and markets you operate in.
Goals can often overlap and be intertwined. There is often a natural tendency to lean towards Environmental and Social, as they are often easier topics to understand and simpler to measure. However, it’s important for any leader or business owner to ensure that Governance is also carefully considered; focus on this area helps to ensure that your business has an effective framework to operate, remains on the right side of local regulations and that stakeholders are trained on compliance and similar aspects, which, as discussed previously, leads to value creation by avoiding costs associated with regulatory and legal interventions.
Your goals should follow SMART guidelines - Specific, Measurable, Achievable, Relevant and Time bound. This will ensure that your objectives are attainable within a certain time frame.
Owners should approve the goals and take an active role in cascading them down through the organisation to ensure visibility, understanding and accountability. Stakeholders’ buy-in and involvement and accountability in delivering these goals is critical.
If for example, your business has a large freight component, then carbon footprint reduction is likely to be a heavily weighted goal. For a people intensive business, the focus may weigh more towards the social aspects, and a listed corporation may have additional goals related to compliance and overall governance.
Creating Your ESG Plan
Although having an overall goal stating that ‘we aim to achieve net zero by 2040’, is commendable, many businesses will fail to achieve that target by not having a clear, detailed and well socialized strategy.
Your ESG plan should be a roadmap to delivering on your agreed ESG goals for your business.
Buy-in to the plan is important at all levels from ownership/leadership through to the most junior members of your team. Each stakeholder has a role to play in the journey, so involving key personnel within the business in the plan creation, will increase awareness and improve accountability. Without alignment across all stakeholders in the organization, your plan is never likely to be realized.
Once the plan is agreed and finalised, it must be integrated across all the business functions. Setting the right tone at the top is essential and Leadership should reinforce the importance, along with clear accountabilities and timelines for delivery, while instilling a sense of togetherness and a collective spirit to ensure success.
Measuring What Matters
Having performed your as-is assessment, created your goals and built out your ESG plan, the important next considerations are measurability and accountability.
Having KPI’s in place is critical and these KPI’s need to be treated with the same level of importance and scrutiny as financial and other operational KPI’s.
After defining suitable KPIs, you must ensure that they are measured and reported accurately. Some larger businesses are managing that process through their financial systems. That way, the information will be objective and consistently prepared, performance can be audited as part of a financial audit, which will provide assurance that the KPIs are not fictitious numbers and have substance and process behind them. Apps and tracking software is also available to facilitate this.
ESG KPI performance should be included in management reports and discussed as a specific agenda item at board/leadership/team meetings. As a further means of driving accountability, ESG targets and goals should be included as part of the measurables in employee and leadership incentive and performance management schemes.
Conclusion
ESG represents a more stakeholder-centric approach to doing business and, although similar to corporate social responsibility, has a broader and more measurable application.
Investors will often value a firm that appeals to its target demographic through its ESG ethos, as this facilitates value creation and growth. Net zero, diversity and inclusion as well as climate risk all feature highly, especially with Venture Capitalists and is therefore relevant to SME’s and owner managed businesses.
Intangible areas, such as brand value, compliance, reputation and the attraction and retention of the best talent can be measured, and therefore positively impact the value of the business and its ability to operate and scale efficiently.
Conversely, failure to develop a strong ESG approach could potentially lead to value destruction as customers and other businesses elect to buy from ESG compliant and sustainable suppliers, the best talent leaves the business and investors look to invest their money elsewhere.
For further information on the authors and Middle East Advisory Partners, contact:
M: +971585879254
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