How Private Equity Firms Can Step Up and Lead on Climate
The Quick Rundown:
Companies and investors are starting to make big things happen — and fast — to address the climate challenge. The private sector is investing in climate solutions, mobilizing talent, innovating, committing to GHG emission reductions, and better climate disclosure. This is just what we need for climate progress. But one large, talented and influential sector can and should be doing more: private equity.
How to Win Friends and Influence People
As my fellow Dale Carnegie acolytes know, salesmanship is a key success factor for building a bigger environmental coalition. More on that in a moment. But first, some background.
Back when I ran The Nature Conservancy (2008–19), I worked hard to persuade business leaders to prioritize environmental problem-solving. Thanks to capable colleagues at TNC and courageous partners in the private sector, CEOs across diverse industries and all over the world stepped up and made bold commitments to address climate change.
How did we sell this idea? We showed that doing the right thing for nature was not just good for the environment, but it was also good for business. Well-designed, ambitious environmental initiatives make business sense. They create new opportunities to grow the top line, reduce costs, lower risks, make better long-term decisions on things like capital spending, and inspire key constituents including employees and customers. Just as importantly, they also please the growing number of shareholders who now care deeply about environmental strategies.
I tried to make the same argument with the titans of the private equity (PE) sector. PE firms have an enormous influence on markets, control a huge number of companies, employ brilliant people, manage large sums of capital, and enjoy extraordinary profitability. Their very modus operandi — buying companies, investing in improvements, and selling them at a profit — is a massive opportunity for environmental leadership.
Alas, my sales pitch here was less successful.
To be sure, we had some nice victories in the broader financial sector. We persuaded a number of individuals, and one PE firm, to donate generously. We built an innovative nature-focused technology accelerator in partnership with the VC firm Techstars. With JP Morgan, we launched NatureVest, a hugely successful first-of-its-kind initiative to catalyze donations funding important conservation deals with billions of investor-provided dollars. And near the end of my time at TNC, we co-launched and were a full partner in a $1 billion investment fund with PE firm RRG that is a game-changer in water conservation investments. That’s a lot to be proud of.
But still . . . I thought we would do much better than that. I’d been optimistic that we could persuade PE firms to pursue environmental opportunities with the same bold approach they took to managing their everyday business. I thought I was a good salesman, and I knew that I had a superb sales pitch. And yet, I wasn’t making the headway I expected.
What would Dale Carnegie Do? That’s easy. He’d advise the following: “Talk in terms of the other person’s interest.” “Try honestly to see things from the other person’s point of view.” “Appeal to nobler motives.” “Throw down a challenge.” And so on. Perfect, right?
So, I urged PE firms to team up with my organization in order to tackle together some big environmental projects. These would be initiatives that would draw on their sophisticated financial engineering skills, bolster their reputations, and improve their standing with key constituents like national governments and multilateral banks. I suggested that they lend us some of their talented staff to boost our creativity and to give their younger deal-makers new problem-solving opportunities to accelerate their career development. I pointed out that capital is now abundant and increasingly seen as a commodity, therefore if an investment firm wanted to differentiate themselves and improve returns, they needed another angle — and what better one could there be than addressing societal challenges like climate change? (See examples here and here).
I had plenty of proposals, rationales, and ideas. I think Dale Carnegie would have approved how I pitched them. But I didn’t close any big partnerships along these lines.
Why? A combination of tunnel vision and habit. Maybe I was ahead of my time. And while maximizing returns is still (and will always be) the highest priority for PE, what that requires today is different than in the past. True, if a deal-maker views the world only through an IRR (internal rate of return) cash flow model, anything that raises costs requires more capital spending, or delays the exit will by definition lower returns. But certainly, the PE business is more complicated than that.
What does success look like for private equity firms in a world transitioning to net zero emissions?
As an outsider, I see PE firms engage in five essential activities:
- Purchasing good companies at the right price
- Helping these companies improve performance
- Selling these companies at attractive valuations, and
- Recruiting and retaining talented people to keep the cycle going
Now ask yourself:
- How will succeeding in each of these five areas look different in the years ahead as the major economies are forced to truly confront the climate challenge?
- What will cause my PE firm to stand out as a global business leader?
- What can we do to be viewed as a preferred partner to prospective selling companies?
- How can we improve our appeal to LPs, employees, and recruits?
- How can we ensure our portfolio companies don’t get left behind in a rapidly decarbonizing world?
- And, most importantly, where can we find new breakout investment opportunities?
These may seem like disparate questions but they all have an answer in common. Focusing on an enormously challenging global issue like climate is one likely way to guarantee your place in a future economy and realize major opportunities. And that’s even before we get to the moral argument: What climate-addressing actions should we take to be a responsible member of a society that seeks to transition to net-zero?
Climate change is happening right before our eyes and with deadly consequences. Customers and shareholders insist that their companies do something about this crisis. And most governments and companies are prioritizing this challenge.
Forward-thinking PE firms should jump in and help lead the climate transformation.
I was whining about all this with a friend over the weekend. She finally became exasperated with me.
She asked: “What would you do if you ran a big PE fund today and wanted to really go after the climate challenge?”
Now that’s a great question, I thought.
Here’s my answer:
What My Private Equity Firm Would Do to Address the Climate Challenge
One obvious step is to study what leading companies are doing on the climate front right now. Why would I want my PE firm to lag behind top companies?
My PE firm commits the following:
1) Align with the Paris Climate Agreement 2050 goals
First, we will sign up to be members of the Science Based Targets Initiative (SBTI). We’ll commit not only at the parent level, but we will also include all of our portfolio companies. Why not? As of today, exactly 1052 companies have signed up for SBTI. If they can do it, we can too.
The SBTI recognizes that different companies and industries face different challenges and therefore allows different levels of ambition. My PE firm, since we choose to be leaders, will set targets for our portfolio companies that are consistent with the 1.5 C goal that is aligned with the Paris Climate Agreement. Since some of our portfolio companies are very carbon-intensive now, we’ll take the next two years (as SBTI allows) to set and validate appropriate and ambitious targets for each of them.
2) Set ambitious interim goals to be achieved by 2030
In the PE business, we know that “what gets measured, gets managed.” We need to ensure that we are on track to meet our long-term goals. Since SBTI targets are goals for 2050, we’ll also set ambitious interim goals to be achieved by 2030.
3) Disclose climate risks
We are aware that financial regulators are calling for all climate risks to be fully disclosed. As a sophisticated financial organization, we think we can add a lot to the efforts underway to get this right. We will pledge to collaborate with the Task Force on Climate-Related Financial Disclosures and other initiatives to determine the best way to make this happen.
4) Prioritize direct emissions and offset the rest
Our top priority will be reducing direct emission reductions. But we will also use nature-based offsets to get beyond what we can do firsthand. We will comply with the Oxford Principles for Net Zero Aligned Carbon Offsetting.
5) Launch a philanthropic conservation fund
We’ll support NGOs with a mission to protect important intact ecosystems and also to improve climate equity and environmental justice outcomes. We’ll do this because we recognize that we are drawing on these organizations’ great work, and therefore, we owe them and need them to be well-funded. We’ll look for opportunities to partner with NGOs too, as we know the two sides can learn a lot from one another.
6) Establish GHG reduction committees: We will form advisory councils for our investors, firm employees, and portfolio company teams to generate new ways to address GHG emission reduction and other climate addressing opportunities. We want to hear from all of our key stakeholders. This is not a “feel-good” move. We’re excited because we know these key stakeholders have great ideas, they want to be heard, and facilitating this will strengthen our culture and improve outcomes.
The focus of this essay is on addressing the climate challenge. But I want my PE firm to be a leader across the spectrum of ESG challenges. So expect us to take parallel steps on that front.
But Aren’t PE Firms Doing Some Good Things on the Climate Front Already?
Yes, there is positive momentum underway that PE firms can build on. Many firms have launched “impact funds” and are also emphasizing investments in clean energy and other climate addressing businesses. Some firms are also acknowledging a need to lengthen investment horizons. And there are probably other worthy initiatives that I’m unaware of (disclosure can be improved).
This is all positive but insufficient. To reach our climate goals, we need a concerted effort that binds these tactics together. We need across-the-portfolio bold and transparent commitments to get to net-zero by 2050, along with robust milestones along the way, period.
We can see how to do this by looking at any number of corporate climate leaders, like this humble yet bold statement by Microsoft’s President Brad Smith. Here’s another good one — this time from Walmart. There are many others.
It Can’t Be As Simple As You Suggest?
I suspect that’s right. I’ve learned in all of my collaborations with the private sector on environmental projects that it’s always more difficult to run a company than it looks. And, likewise, it’s also more complex to set up and achieve the right environmental initiative than an outsider might understand. That’s probably even more true for PE, given the diversity of companies they control.
But I’ve also learned this: the key is to get started. That’s the only way to make progress. My checklist will work well — as a starting point. Maybe some of the goals will need to be revised, which is fine. Maybe we’ll learn that there are other initiatives for PE firms that can make a bigger difference. All of this is new and everybody is learning as we go forward. The best way to develop an ambitious, but doable plan is likely through some good back and forth between PE firms, outside advisors (including NGOs), and other key constituents (investors, employees at both the parent and portfolio companies). But we still need to start somewhere.
Start A Race to the Top
The upside here can be very significant. All we really need is for a few PE firms to step up and take on this challenge. Stakeholders will inevitably encourage the rest to hustle and catch up. The reward for doing so will be two-fold: progress in achieving our climate goals, and PE firms that are more successful in a rapidly changing world.