ESG, which stands for environmental, social, and corporate governance, is an emergent set of sustainability standards that investors are increasingly applying to public companies.
“Right now, there’s a great deal of uncertainty on the regulatory or reporting requirements that even public companies may have to follow for ESG reporting,” says Seth Rensberger, Director, Risk and Control Advisory Services, Clark Schaefer Consulting. “But there’s a growing sense that an upcoming SEC proposal would require a registrant to include certain climate-related information in its registration statements and periodic reports, which would make sustainability reporting mandatory.”
As the SEC explores establishing ESG requirements for public companies, ESG standards are increasingly being indirectly applied to private companies, as well.
“Public companies deal with third-party vendors that are private, and those public companies are going to push those ESG requirements down to their private vendors,” says David Coomer, Shareholder, Director of Assurance Services, Clark Schaefer Hackett. “So, the private sector can’t ignore ESG.”
Smart Business spoke with Rensberger and Coomer about ESG and how it’s affecting private middle-market companies.
Why should ESG be a concern for private companies?
For private companies, the consequences of not adopting ESG-related standards could be missing out on opportunities within a competitive bidding situation. As customers start looking at factors beyond pricing, not having a strong ESG position can put a company at a disadvantage in the marketplace.
Additionally, a company’s ESG standing could influence the value of the business at the time of a sale or liquidity event, especially when PE firms are involved. When seeking capital from a large institutional investor, they’ll want to know how that capital is being deployed.
Further, private companies that could be acquired by a public company will have an ESG score considered during due diligence, and that ultimately will affect their value. Similarly, if a middle-market company aspires to go public, they need to get their ESG standing in order.
Overall, ESG will be another data point public companies use to evaluate the suitability of vendors and an increasingly more significant factor in M&A transactions. Private companies that capture ESG data in a reliable format, and can show themselves to be favorable, will have an advantage.
What aspects of ESG might interest stakeholders most?
The environmental impact of a business is likely to be a significant part of ESG reporting and data captured. For example, consider a manufacturing business with a complex supply chain. Stakeholders will want to understand the environmental impact from sourcing raw materials, transporting those materials to factories, converting them to finished goods and transporting them to customers
The social aspect, with diversity, equity and inclusion, will be scrutinized because it’s an issue that’s discussed with increasing frequency.
Another pressing issue is data security as there’s a lot of concern about a company’s cybersecurity environment.
Otherwise, from a governance perspective, there will be interest in how a company’s board is composed, how they’re managing executive compensation, and protections and channels for whistleblowers, all examples of the areas where middle-market companies may be impacted.
How can companies prepare?
Private companies need to be prepared to identify the information and metrics relevant to eventual ESG reporting that stakeholders will be requesting. That means building systems and an internal control environment that enables a company to gather data and facilitate reporting of quality information during the vendor qualification process that many businesses go through.
Accounting firms can help companies by evaluating their organizations through an ESG lens and aiding companies as they dial in and establish systems to capture that information. They can also provide advisory guidance on building a reporting structure and perform ESG readiness assessments to prepare companies for future ESG assessments.●
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