Here’s How VCs Can Respond to Sustainability Demands From LPs

• Institutional investors are looking to clean up their portfolios by focusing on sustainable VCs.
• UK insurer Aviva is set to pump £50 million ($67 million) into more sustainable funds.
• VCs will need to engage their LPs and collaborate effectively to meet ESG demands.

Sustainability hasn’t always been at the top of the agenda for the venture capital sector, but making it so has fast become a priority for the institutional investors who back it.

The decision by Aviva, one of Britain’s biggest insurers, to pump £50 million ($67 million) into VC funds that focus specifically on sustainability is a case in point. It marked a key shift in the insurer’s approach to venture capital, where it has largely focused on startups more closely linked to its own industry since 2015.

Though relatively small, the investment demonstrates that green VC firms will become increasingly important to institutional investors.

Similar moves are to be expected with PwC predicting private market assets under management linked to environmental, social and governance (ESG) matters could rise to a high of €1.2 trillion ($1.35 trillion) by 2025, up from €253 billion in 2020.

In part, this is driven by growing regulatory pressure on institutions to clean up their portfolios, as well as from their clients who want to see them take sustainability far more seriously. Aviva, for example, has set itself a 2040 target to reach net-zero carbon emissions.

Aviva has assessed over 100 funds but has backed just one so far, according to Ben Luckett, the insurer’s chief innovation officer.

“The dialogue we have is around making sure targets are meaningful and they’re not just there for the sake of it as part of a high level agenda that people talk and forget about,” Luckett says. “It needs to be meaningful, impactful and actually set at the right level.” 

For VCs, many of which turn to institutions such as insurers, pension funds, endowments and others to raise money for their investment vehicles, being mindful of the changing priorities of their backers is vital. 

William McQuillan, partner at transatlantic VC firm Frontline Ventures, agrees that many larger LPs now have requirements for the VC fund managers they engage with, particularly around the reporting of ESG data.

“While none of our LPs require anything above and beyond reporting, we have started to see some impact-focused LPs setting targets or goals as part of their capital and returns to other managers,” he says.

Despite this, McQuillan believes institutions are “still learning what the right metrics are” to measure to assess sustainability performance, making the process one that tends not to result in heavy-handed demands being placed on VCs.

Nonetheless, VCs will need a robust plan of action to improve the sustainability credentials of their portfolios. One VC fund that believes a robust approach to ESG across a diverse range of early-stage startups is possible is London-based Talis Capital. 

The emergence of cross-industry groups, such as LP and VC community VentureESG, has created an opportunity for collaboration on best practices, according to Matus Maar, a managing partner and co-founder at Talis.

“Collaboration between funds will be absolutely essential to see real progress, particularly when it comes to developing a common system of ESG reporting to reduce the burden on companies, who may currently have different ESG reporting requirements for each investor,” he says.

The timing couldn’t be more important for the VC sector. Just a month after the UN’s COP26 summit laid bare the consequences of not addressing climate risks, institutional investors will approach 2022 with a much closer eye on the sustainability credentials of their investments.

Venture capitalists will need to be ready.