ESG for SMEs
Nov 04, 2023
ESG (Environmental, Social and Governance) strategies are all the rage. But that’s just for big publicly-traded companies, isn’t it?
Not so fast.
Small and medium enterprises (SMEs) and non-profits are discovering that they’re in the same boat. Just like major corporations, they face a need to meet expectations about their ESG strategy. If ESG is not on your radar yet, it soon will be.
“There’s increased pressure from stakeholders to be more transparent and accountable on ESG performance no matter what the size of the company is.” - Roopa Davé, Partner, Sustainability Services, KPMG
ESG is becoming a priority for every organization, regardless of its size, scope, and the sector where it operates. How should you and your board get started?
ESG focuses on a company’s efforts in three areas - Environmental, Social, and Governance.
- Environmental matters focus on climate change, carbon footprint, emissions, energy use, land conservation, recycling and waste management, and water and air quality.
- Social matters focus on issues such as ethics, privacy, cyber security, labour practices, child welfare, health and safety, human rights, diversity, equity and inclusion, Indigenous rights, Truth and Reconciliation, employee engagement, workforce development, and workplace culture.
- Governance matters include board composition, director independence, board evaluation, director and executive compensation, succession planning, and engaging the external auditor.
From the board’s point of view, the three ESG areas should be viewed holistically rather than in silos. That’s because environmental, societal and economic wellbeing are all intertwined. When you think about it, this interdependence is clear. For example, climate change is not just an environmental issue with economic risks. It’s also a social justice issue because it imposes a greater burden on racialized and low-income communities.
In the same way, ESG risks and opportunities overlap. You might think of governance as distinct from Environmental and Social issues. But boards now recognize that they’re intertwined. Before you can make meaningful progress on climate and social change, you need the foundation of a strong governance structure.
The ESG Imperative
Conversations about ESG are taking place in boardrooms everywhere because of two imperatives – moral and economic.
Moral Imperative: With growing public concern about the effects of climate change, and social inequity laid bare by the pandemic, SMEs – like everyone else - are asking themselves what part they can play in making this a better world for everyone.
“There’s a generational shift toward demanding stronger ESG performance … . Younger family members and their boards are concerned about their own legacy.” - Roopa Davé, KPMG
Economic Imperative: ESG brings with it opportunities for businesses if they’re able to seize them. SMEs that embrace ESG can attract investors, appeal to customers that want to support a ‘green’ company and help attract and retain employees who want to have a positive impact on the world.
“Customers, employees, investors and other stakeholders are increasingly expecting companies to make more socially and environmentally responsible decisions,” – The Globe and Mail
Investors. SMEs with an ESG strategy are more likely to attract sustainability-focused investors. Lenders are increasingly demanding environmental and social policies from borrowers. And banks, venture capital firms and private lenders all want to see where boards stand on gender parity, diversity, and transparent governance.
“All lenders ask questions about ESG now, because better ESG is perceived as less risk.” - Francisca Quinn, President, Quinn and Partners
Customers: Customer preference is a big driver of ESG, creating a differentiation opportunity for progressive companies with sustainable products and socially-conscious service offerings. Business-to-business customers often want to know how green their suppliers are.
Employees. Millennial and Gen Z employees prefer to work for companies that have a positive impact on the world. And employees who are treated well and enjoy a workplace free of discrimination and harassment are more productive and less likely to leave their jobs.
Regulators. In some cases, tougher regulations are already pushing SMEs on ESG policies. A company with an ESG strategy will be better able to handle the increasing regulatory requirements anticipated in the future.
The SME Advantage
When it comes to ESG, smaller companies may have an advantage over larger ones. For one thing, they’re more agile - they can make decisions faster and move more quickly than their public counterparts.
“Private companies are typically smaller, leaner, and less bureaucratic than their large public company counterparts. A lot of these sustainability initiatives require a company to move fast. Frankly, that’s just harder to push through in a public company.” - Vinay Shandal, Managing Director and Partner, Boston Consulting Group
SMEs are often closer to their customers and tend to be located near the communities they serve. Many have a brand, product, or service that their community knows about and identifies with.
And when an SME goes green, it may find savings with a few relatively painless changes, like moving to digital receipts, using recycled or compostable packaging, improving waste diversion, or upgrading energy efficiency.
The Board’s Role
The board ensures ESG is integrated into strategy and oversees emerging risks and opportunities. But boards have different levels of maturity and resources. A one-size-fits-all approach won’t work.
Step 1: Understand the Landscape. This is the learning phase, during which the board gains a broader and deeper understanding of ESG issues and trends. While the board eventually needs to learn about all three ESG categories, it’s best to start with the area that aligns most closely to the organization’s purpose.
Step 2: Decide Where Board Oversight is Needed. This is a prioritization phase, during which the board scopes out the various issues and decides where the board will focus its oversight. Doing this requires identifying how each ESG matter relates to the company’s purpose, strategy, and risks.
Step 3: Allocate Responsibility. In this phase, the board decides whether the full board or a committee will take primary responsibility. Oversight might be assigned to an existing committee or split among several committees, or the board might decide to establish a new ESG committee.
Step 4: Conduct a Gap Analysis. In this phase, the board finds out the company’s current status in each identified area.
Step 5: Prioritize and Plan. With this phase, the organization moves into action mode, prioritizing issues, developing plans, and assigning resources to close the gap. The board should take care to ensure plans are integrated into the organization’s culture and operations, rather than being just an add-on.
Step 6: Monitor and Report. Finally, the board should determine what metrics it wants to monitor and how often, as well as what information will be disclosed to interested stakeholders.
Where should an SME start? The first piece of advice is to start with learning – or in some cases unlearning what you thought you knew.
The second piece of advice is to prioritize initiatives that align with the company’s purpose. For a resource company, that might be energy efficiency or reducing GHG emissions, for a social service organization it could be Truth and Reconciliation, and for a financial services company it might mean diversity in hiring practices.
Finally, the experts advise you not to copy what the big companies are doing. Don’t start with writing long, elaborate ESG reports. Instead, focus on practical, straightforward steps over the short, medium, and long terms.
- In the short term, focus on quick wins such as being more energy efficient and cutting waste.
- Over the medium term, focus on employee well-being and community support.
- In the longer term, look at lasting steps that will enhance the company’s brand - such as reducing wasteful packaging, switching to electric vehicles, and seeking recognition.
Making responsible investment choices is another way some SMEs can enhance their ESG strategy. In charitable foundations or member-owned SMEs like credit unions, co-operatives, and mutual companies, investments are a common area for board oversight. For these organizations, adding ESG criteria to investment guidelines enhances their long-term effects on society and helps shield them from criticism.
When viewing investment managers through an ESG lens, boards will find two basic investing strategies suited to SMEs – there are others, but they require significantly more effort, capital, and resources.
- Exclusionary screening is the simplest way to approach ESG investing. Boards exclude companies based on their core business activities. With this approach, it’s possible to exclude whole industries such as alcohol, tobacco, gambling, or firearms.
- Best-in-class selection means choosing companies with a good ESG track record. There are indices that measure ESG performance, allowing the board to compare companies against their sector and peers within the industry.
Making a Difference
We can’t just leave everything to the big guys. Small and medium enterprises, private businesses, and non-profits all have a role to play in enhancing our environmental, social, and economic health to make our world a better place for all of us. Fortunately, with board oversight and engagement, SMEs can do so and not only survive, but thrive.
Want to make a difference? As a director, you can help your board start the journey by suggesting learning activities, sharing information, asking tough questions, or just having the courage to put up your hand and say, “I think we should be doing this.”
- ESG is not just for big companies. In fact, smaller companies may have an advantage.
- ESG is not just about risk, it’s about opportunity.
- The board’s role is to ensure ESG is considered in the organization’s strategy and to exercise effective governance of ESG.
- Don’t try to copy what big companies do. Find practical, straightforward steps over the short, medium, and long terms.
- Make sure ESG is integrated into your investment choices.
We welcome your suggestions below.
Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com
– an online membership with practical tools for board directors who choose a growth mindset.
Originally published January 30, 2022
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