ESG analysis for small-cap companies
Given the challenges that smaller companies face when it comes to dedicating significant resources to sustainability efforts, there is a perception that they have been slower to adopt ESG relative to their larger counterparts. But in reality, many smaller companies are doing much more when it comes to sustainability and ESG than can be seen at first sight. There is a compelling opportunity for long-term, fundamental investors to uncover unrecognized growth and undervalued companies in the smaller company equity universe. ESG factors will play a significant role in this—particularly given the increasing regulation.
Because ESG is not a straightforward topic, a one-size fits-all approach rarely works—meaning third party data, even when it does exist, is often more helpful as an input for consideration than as a comprehensive measure of a company’s ESG profile.
In addition to this, smaller companies will tend to have more limited resources available to assess, disclose and report on ESG and sustainability issues, compared to their large cap counterparts. When the required disclosures and ESG regulations are rapidly developing and being enhanced, for all companies irrespective of size, smaller companies may face disproportionate burdens
As a result, some smaller companies may end up having apparently weaker ESG profiles than are warranted.
While these challenges should not be underestimated, they can also present opportunities to identify unrecognized growth and undervalued companies. Due to the information gaps that exist across the smaller companies’ universe, for instance, there are often opportunities to identify good companies—with strong management teams, good long-term prospects and positive ESG outlooks—that are undervalued in the market.
Engaging in frequent, in-depth conversations with management teams—rather than simply excluding companies that do not ‘tick the box’ on paper—not only offers a better sense of whether a company is moving in the right direction (or not), but also presents opportunities for value creation.
Our recommendation for VCs or any investor in small-cap companies: integrating ESG factors into fundamental, bottom-up investment analysis and decision making, taking a dynamic and forward-looking approach to analyzing a company’s ESG practices and actively engaging with management teams to improve ESG outcomes. To do exactly this, we recommend starting with our stratesgy’s readiness-check and analysis refresh modules.