By Rajib Debnath, Neha Malhotra, Suhaanvi Sood
The global IPO market has grown stronger in recent years. Going public and demonstrating transparency and the larger purpose of providing value to stakeholders is a milestone for a company. However, with the outbreak of COVID-19 leading to market volatility, the world has witnessed a radical shift in investment patterns. It showed that ESG (Environment, Social & Governance) compliant companies performed better and were much more resilient in the stressed market phase. This has led investors to make more responsible decisions and focus on value investing, leading to a decrease in their risk appetite.
Investors’ increased awareness of sustainability has been reflected in companies adopting and implementing sustainable strategies in their business models. The integration of ESG policies into business models reflects a company’s long-term prospects, improved market reputation, robust competitiveness and financial superiority of its competitors, leading to transformation of the entire value chain and ecosystem. In addition, customers expect companies to help improve the environment and society, and prefer brands that align with their belief systems.
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Companies considering an IPO must plan to take the route and declare their commitment to ESG early in the pre-IPO phase to increase credibility and visibility. Therefore, voluntary ESG communication/disclosure in the pre-IPO phase is a key factor for a successful capital market debut. Early stage ESG insights and measurements benefit IPO valuation and financial performance. This includes a proprietary ESG assessment, which increases the level of transparency and attracts the interest of responsible investors, including investment funds, as investors perceive ESG compliant companies as less risky. In addition, greater transparency towards its stakeholders reduces the asymmetric information that demonstrates that the company is more trustworthy.
The three ESG metrics Environment, Social and Governance quantify the company’s impact on the environment, society and responsibility towards its employees as well as the company’s outlook on its corporate governance. In order to simplify the ESG assessment process for investors, rating institutes have introduced the concept of ESG ratings/scores. The ESG score shows the company’s propensity to mainstream ESG, which has become one of the most critical factors for stakeholders, especially in the pre-IPO phase. Companies with strong ESG scores have a major competitive advantage that allows them to generate superior returns. Consequently, investors would not demand higher compensation in return and the IPO would not be undervalued compared to a non-ESG company.
It is observed that ESG ratings will soon become mandatory, as will credit ratings for companies wishing to raise capital. During the bookbuilding process, the underwriter attempts to determine the price at which an IPO will be offered. In addition, the process of an IPO often involves institutional investors, who are often considered to be well-informed investors. In addition, the underwriter must incentivize the institutional investor to disclose what price they are willing to pay in order to facilitate the process of correctly pricing the IPO shares.
Venture capitalists and private equity investors have increased their requirements for conducting due diligence and incorporating ESG aspects when evaluating potential investments, as ESG-integrated funds remain relatively protected. They want to know at an early stage whether the company bears sustainability risks that could have a negative impact on the company’s value. The world’s largest investors are investing in companies that are well-positioned to benefit from the transition to a green and sustainable economy and are willing to protect their portfolios from ESG downside risks.
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As part of the pre-IPO research and ESG assessment, companies should reassess existing models with the aim of understanding their level of sustainability, assessing their performance on all material ESG aspects, developing a strategy driven by top management and is connected to the corporate purpose that will create and secure a long-term competitive advantage.
looking ahead
A company’s ability to create positive environmental and societal impacts is rapidly transforming competitive advantage, and companies must simultaneously integrate ESG considerations into every component of the business to capitalize on the value of this transformation.
To appeal to the most responsible investors possible, companies need to broaden their perspective and see ESG as more than just compliance. For companies planning an IPO, ESG is more “pre-financial” information than “non-financial” information and acts as a public company before going public.
(Author Rajib Debnath is a Partner and co-author Neha Malhotra is Director – Sustainability & Developmental/CSR Services at Nangia Andersen LLP. The views expressed in the article are those of the author and do not reflect the official position or policy of FinancialExpress.com. )
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