Future-proofing investment strategies

How ESG will be increasingly vital for value creation


Authored by RSM Canada

An interview with RSM Partner Ben Gibbons, published in the May 2021 issue of Private Equity International's Future of Private Equity report.

Which aspects of ESG will be most important to private equity firms three years from now?

Historically, interest has been more weighted to the “E” and the “G” than the “S.” That is partly because the “E” and “G” are simpler to measure and report on. It is easier to explain the impact you have on them as a private equity investor. Recently, however, we have seen more interest than before in the “S,” generated partly by big social movements such as Black Lives Matter. Three years from now, I think the relative importance of all three factors will be equally important.

One important “S” area is diversity in leadership. Having leaders from different backgrounds and with different perspectives, such as men and women, different ethnic groups and people who are LGBTQI+, creates diversity of thought. Studies show that this is good for public companies’ shareholder returns, and we know it translates to being beneficial for private equity funds and their portfolio companies too.

Beyond a greater evenness of interest in the E, S and G, what kind of ESG strategies will private equity firms implement over the next few years?

It will be a case of evolution rather than revolution, but positive ESG screening will be more standard. By this I mean not just a checking-the-box exercise. I mean having a policy in place and moving on. There will be a sharper focus on more proactive ESG measures. There will be a great deal of impact turnaround—taking businesses that can be modernised in a way that increases value, through practical implementation of ESG principles. That might be, for example, by moving a vehicle fleet and production practices to green energy. It could involve turning waste management companies that have historically used landfills into circular economy businesses. Private equity firms will seek opportunities to create value by marrying financial and ESG returns.

These ESG strategies will be a combination of risk management—future-proofing businesses to protect them against changes already occurring in the economy and society—and putting the company at the forefront of change.

Sceptics might say the problem is that the future has already been priced in—that companies with good ESG are already a bit too expensive. How might this situation develop?

Companies further down the path of ESG maturity are highly valued, making it harder for private equity firms to find deals in such companies. However, impact turnaround can create multiple expansions through the organic growth of businesses that are early in their ESG journey or have not even started it.

Will specific impact investing funds remain popular in private equity in three years’ time?

Impact investing will become more intertwined with the standard way of approaching the investment life cycle. Limited partners will conclude that they have less requirements for specific impact funds, because of ESG initiatives within traditional funds. For this reason, the number of new specifically focused impact funds will probably eventually stop rising.

For ESG issues to grow in importance, must we wait until a new generation comes into leadership positions?

I do not believe we need to wait for a generational change. Private equity firms face significant competition for top talent, not only with other private equity firms, but also with investment banks, consultants and other professional services firms. The private equity industry has seen ESG awareness become a priority for new talent within firms—something that gives them an additional sense of purpose when they come into the office every day. Management teams are aware of this and are responding. Because of that, we do not have to wait for analysts and vice presidents to become directors and partners before these changes occur. They are occurring now.

How will digitalization improve due diligence and value creation in the future?

In due diligence, we are already seeing the digitalization of data analytics and business intelligence both to mitigate risk and to make deal-making more efficient. In the future, we obviously cannot do without human intervention. However, with the advancement of real-time auditing, which will put more up-to-date, continuous and holistic information in the heads of the deal team, interpretation of the data and the trends and observations that result become key. This will include not just financial data on measures such as EBITDA, it will also encompass a more macro set of data.

Consider the example of a consumer products company. In the future, data can be used to marry underlying internal financial data with operational sales data. This will include looking at data on the operation of the supply chain. For example, it could be used to check the sourcing of the key ingredients of an organic muesli bar. Private equity investors could then overlay that supply chain information with data on consumer trends, macroeconomic information and data from social media. Private equity investors could look at what all this means, from the perspectives of both risk mitigation and opportunity.

This data could be considered at the due diligence stage. However, it could and should also drive value creation after acquisition.

Could data be used to make due diligence quicker in the future?

At the moment, exclusivity periods, during which the diligence is done, are usually set at between one and three months. The sophisticated use of data will likely shorten specific areas of diligence in the future so that these diligence components will tend to take one rather than three months. However, there is a cost in making due diligence too short—I think we will see the continued evolution of more holistic diligence, which may require these timelines to remain relatively constant. That could marry macroeconomic and social media trends and look at other areas of interest, such as the online presence of leadership and board members. Private equity investors want to make sure that the human capital of a company is not going to create risk after the deal is closed.

Will data be used to make private equity firms and portfolio companies more agile?

Private equity firms will slice and dice microdata to enhance strategy. They will also use predictive analytics to stay ahead in their investment strategy and decision-making. However, the focus will be on more than just sales numbers and other financial information. For example, private equity firms can use real-time key performance indicators from the supply chain, enabling them to deal with problems before they become embedded. This means not waiting for each monthly financial report to see that sales targets have been missed because of a problem with a critical component in the supply chain. Instead, machine learning and artificial intelligence can connect this information to a dashboard at the fund level. The PE fund can then see that there is an issue with this critical component and head off the problem by dealing with it earlier.

What about the future role of automation in value creation?

Automating processes can significantly increase value. I have already mentioned the automated real-time monitoring of critical components in the supply chain. However, automation can add value throughout the portfolio company, including order fulfilment and other parts of the supply chain, all the way through to support functions such as human resources. The more manual and time intensive tasks that can be automated, the more value can be created by allowing talent to focus on areas to drive productivity and growth.

Another opportunity comes from something we already see—portfolio companies with a high level of technological maturity are spinning out new businesses specifically in the field of data intelligence. This opportunity is likely to increase.

If future success in private equity lies in good ESG and technology and data practices, do private equity firms understand this? How good are they at responding?

I doubt anyone in private equity would disagree with any of the points we have discussed. However, many private equity firms are slower to adopt as they continue to make good returns for limited partnerships without a big change in ESG and technology and data use. They are doing this through their traditional model of establishing a good proprietary deal flow, buying and building, and implementing organic growth. These firms should take note, however, that ESG issues and data are not only becoming more important, their importance is accelerating. A lot of private equity houses will have to catch up or be left behind.

Aside from the struggle to generate value, interest in ESG in particular will be propelled by two specific parties: LPs and the talent coming into private equity. Because of this, if firms do not move with the rest of the pack, they will lose two wars—the talent war and the capital-raising war. As for data, its intelligent use will help private equity firms stay ahead in both proprietary deal sourcing and investment strategies that drive returns.

Private equity firms that have moved further down the technology, data and ESG paths are already doing better, and will continue to do better, when it comes to returns and other metrics.

In your speciality area of consumer industries, do you see any other big future trends?

We hear a lot of talk at the moment about the sustainability of food. Organic production is one aspect, but the issue is broader than this, and the practice of sustainability of the entire farm-to-table food system is of increasing importance to consumers. For example, blockchain can be used to help assess whether beef comes from a sustainable source or from cows reared on pasture created by felled rainforest.

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This article was written by Ben Gibbons and originally appeared on 2021-05-05 RSM Canada, and is available online at

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