6 Common Challenges to ESG Due Diligence (And How to Overcome Them)

Every investor knows of the pressure to “do ESG.” But knowing of it and knowing how to go about it are two different beasts. Let’s start with the most common challenges PE investors face when attempting to bake ESG considerations throughout business operations.  

ESG due diligence challenges and solutions

Lack of standardized ESG metrics and reporting

Challenge: The absence of consistent and comparable ESG data makes it challenging to evaluate and compare current and future portfolio companies' ESG performance.

Solution: Engage with industry peers and organizations to advocate for standardized ESG metrics and reporting frameworks. Encourage portfolio companies to disclose relevant ESG information and support initiatives that promote transparency and standardization, such as the EDCI, SASB or GRI.

Limited access to reliable and comprehensive ESG data

Challenge: Obtaining accurate and up-to-date ESG data can be difficult, especially for private companies or those operating in emerging markets.

Solution: Collaborate with reputable ESG data providers that specialize in private markets or emerging markets. Leverage their expertise to obtain reliable ESG data and insights. Consider engaging third-party consultants with ESG expertise to support data collection and analysis. Reach out to Tablecloth for more information on how we can help you accelerate your ESG integration process. 

Difficulty in quantifying the financial impact of ESG factors

Challenge: It can be challenging to quantify the financial implications of ESG risks and opportunities accurately.

Solution: Engage with industry experts and conduct in-depth analysis to quantify the financial impact of specific ESG factors in each portfolio. Establish policies and practices to regularly collect and dissect quality ESG data, as well as scalable processes to tie those data insights to bottom line performance. Develop comprehensive financial models that integrate ESG considerations to assess the potential value creation and risk mitigation opportunities.

Limited expertise and resources for conducting thorough ESG due diligence

Challenge: Private equity firms may lack the necessary internal expertise and resources to conduct meaningful ESG due diligence.

Solution: Consider building internal expertise by hiring dedicated sustainability professionals or training existing staff on ESG issues. Collaborate with external ESG consultants or engage specialized service providers to support the due diligence process. Establish partnerships with research institutions or industry associations that offer resources and guidance on ESG integration.

Integration of ESG considerations into investment decision-making

Challenge: It can be difficult to identify the most relevant ESG factors at both the fund level and the portco level when dealing across multiple industries and governance structures. It’s even more challenging to use those factors to inform investment strategy. 

Solution: Foster collaboration between investment teams and ESG subject matter experts. Encourage open dialogue and knowledge sharing to ensure that ESG considerations are thoroughly evaluated alongside financial analysis. Develop decision-making frameworks that explicitly incorporate ESG factors and metrics into investment models. Provide training and education to in-house team members in every department to build a wealth of organizational knowledge of ESG integration.

Limited engagement with portfolio companies on ESG issues

Challenge: Once the investment is made, engaging portfolio companies to improve their ESG performance and implement ESG action plans can be challenging.

Solution: Actively collaborate with portfolio companies on ESG matters by establishing clear expectations and goals during the investment process. Provide resources and support to help portfolio companies enhance their ESG performance. Offer guidance and best practices, and establish regular communication channels to monitor progress. Consider appointing ESG-focused board members or advisors to provide oversight and guidance.

What does this mean for PE investors?

While it may seem daunting to deliver non-financial results without sacrificing financial returns, it’s completely possible to excel at both with a well-crafted ESG strategy. Recognizing these common challenges will leave PE investors better equipped to navigate the steps needed to overcome them. Find out how to put ESG due diligence into action with the other articles in the series: 

• How to Incorporate ESG into Investor Due Diligence
• ESG Integration In Private Equity: From Due Diligence To Exit