Are you planning an IPO? Why ESG should be on your checklist

By Rajib Debnath, Neha Malhotra, Suhaanvi Sood

The global IPO market has grown stronger in recent years. It is an important step for a company to go public and demonstrate transparency and a larger goal of delivering value to stakeholders. However, with the COVID-19 outbreak causing market volatility, the world has seen a sea change in investment habits. Companies that comply with environmental, social and governance (ESG) standards have been found to perform better and be much more resilient during difficult market times. This led investors to make more responsible decisions and focus on value-oriented investments, which led to a decrease in their risk appetite.

Growing sustainability awareness among investors has resulted in companies adopting and implementing a sustainability strategy in their business models. Embedding ESG policies into business models reflects a company’s long-term prospects, enhanced market reputation, strong competitiveness, financial outperformance of competitors, resulting in transformation of the entire value chain and ecosystem. Moreover, customers also expect companies to contribute to the betterment of the environment and society and prefer brands that match their belief systems.

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Companies considering an IPO should plan to go the route and declare their commitment to ESG from the pre-IPO stage to build credibility and visibility. Thus, voluntary ESG communication/disclosure at the pre-IPO stage is a key factor for a successful start in the capital market. The early stage of ESG insight and measurement benefits IPO valuation and financial performance. This includes its own ESG assessment which improves the level of transparency, attracting the interest of responsible investors, including that of investment funds, as investors perceive ESG-compliant companies as less risky. In addition, greater transparency towards its stakeholders reduces asymmetric information demonstrating that the company is more trustworthy.

The three ESG indicators – environmental, social and governance – quantify the company’s impact on the environment, society, responsibility towards its employees and the company’s vision vis-à-vis its governance. In order to simplify the ESG assessment process for investors, rating institutions have implemented the ESG rating/score concept. The ESG score demonstrates the company’s propensity to integrate ESG, which has become one of the most critical factors for stakeholders, especially at the pre-IPO stage. Companies with good ESG scores have a great competitive advantage that allows them to generate above-average returns. As a result, investors would not demand higher compensation in return and the IPO would not be undervalued, relative to a non-ESG compliant company.

It is observed that ESG rating will soon become mandatory in the same way as credit ratings for companies seeking to raise capital. During the process of building an order book, the underwriter attempts to determine the price at which an IPO will be offered. Additionally, in the IPO process, institutional investors are often involved and are often seen as well-informed investors. Additionally, the underwriter should create incentives for the institutional investor to reveal the price they are willing to pay to facilitate the process of correctly pricing IPO shares.

Venture capitalists and private equity investors have increased their requirements for due diligence and integration of ESG aspects when evaluating potential investments, as ESG integrated funds remain relatively shielded. They want to know at an early stage whether the business has sustainability risks that could negatively impact the value of the business. The world’s largest investors are allocating capital to companies well equipped to benefit from the transition to a green & sustainable economy and are willing to protect their portfolios against downside ESG risks.

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As part of pre-IPO research and ESG assessment, companies should reassess existing models with the aim of understanding their degree of sustainability, assessing their performance in all material ESG aspects, designing a strategy driven by management, linked to the business objective that creates and captures long-term competitive advantage.

Look forward

A company’s ability to create positive environmental and societal impact is rapidly reshaping competitive advantage and companies must simultaneously integrate ESG aspects into every part of the business to take advantage of this transformation.

To tap into as many responsible investors as possible, companies need to broaden their perspective to consider ESG more than just compliance. For companies planning an IPO, ESG is “pre-financial” information rather than “non-financial” information and acts as a listed company before going public.

(Author Rajib Debnath is a partner and co-author Neha Malhotra is Director of Sustainability and Development/CSR Services at Nangia Andersen LLP. The opinions expressed in the article are those of the author and do not reflect the position or the official policy of )

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