ESG and impact investing in VC: The relationship between company-level ESG and VC fund performance

Abstract

Sustainable investing has garnered increasing popularity in both public, and more recently, private markets, with the promising potential of “doing good while doing well.” Studies on VC impact investing have shown mixed results, potentially due to their willingness-to-pay for their dual mission. However, within VC, little research has been done on how to incorporate ESG concerns to reduce risk and improve financial performance. Therefore, we aimed to understand to what extent funds investing in companies with greater ESG scores would have better financial performance, and how VC firm level factors, such an impact-focus strategy or ESG expertise, affect this relationship. Furthermore, we assessed the link between impact companies and fund-level returns. Using Preqin’s VC fund performance data, we found that company-level ESG scores were not associated with net IRR, even when excluding impact-focused funds. However, ESG scores were tied to lower IRR:TVPI, both when including and excluding impact-focused funds. Additionally, a greater proportion of impact companies was associated with lower fund financial performance, as measured by IRR:TVPI. Finally, ESG expertise alone showed no association with financial performance, but after excluding impact funds, the interaction term between ESG score and ESG expertise showed a negative relationship with IRR. Overall, even when accounting for an impact-focused strategy, we did not find evidence for a link between higher company-level ESG scores and greater fund-level financial performance. The practical implications of these findings do not support a strategy of greater implementation of ESG in VC for greater financial performance. Future research should investigate these relationships using alternative metrics of fund performance, impact fund designation, and assess the effects of ESG on startup survival. Key Words: venture capital, financial performance, portfolio company, impact investing, ESG expertise, ESG score, IRR, TVPI