By Rajib Debnath, Neha Malhotra, Suhaanvi Sood
Global IPO market has grown stronger over the last few years. It’s a milestone for a company to go public and showcase transparency and larger purpose of bringing value to stakeholders. However, with the outbreak of COVID-19 resulting in market volatility, the world has observed a radical shift in investing patterns. It was seen that Environment, Social & Governance (ESG) compliant companies performed better and were much more resilient during the stressful market period. This has resulted in investors taking more responsible decisions and focusing on value driven investments, leading to decrease in their risk appetite.
The rise in sustainability awareness among investors has reflected in companies adopting and implementing sustainable strategy in their business models. Integrating ESG policies into business models reflects long-term prospects of a company, improved market reputation, robust competitiveness, outperforming their competitors financially, resulting in transforming the entire value chain and ecosystem. Further, customers also expect companies to contribute towards the betterment of environment and society and prefer brands which align with their belief systems.
Companies envisioning IPO need to plan to walk the path and declare their commitment to ESG early at Pre- IPO stage to boost credibility and visibility. Thus, voluntary ESG communication/ disclosures at Pre- IPO stage is a key factor for a successful capital market debut. The early stage of ESG insight and measurement benefits IPO valuation and financial performance. This includes own ESG assessment which enhances transparency level, attraction of responsible investor’s interest including that of investment funds as investors perceive ESG compliant companies less risky. Further, higher transparency towards its stakeholders reduces the asymmetric information demonstrating the company is more trustworthy.
The three ESG metrics- environmental, social and governance, quantify company’s impact on the environment, society, and the responsibility towards its employees and the company’s outlook towards its governance. To uncomplicate the ESG evaluation process for investors, rating institutions have established the concept of ESG rating/ score. ESG score demonstrates company’s inclination towards mainstreaming ESG, which has become one of the most critical factors for stakeholders, especially at pre-IPO stage. Companies with strong ESG scores have great competitive edge which enables them to generate returns beyond normal. Resultantly, investors would not demand higher compensation in return and the IPO would not be under-priced, when compared to a non-ESG compliant company.
It is observed that ESG rating will soon become mandatory just as credit ratings for companies looking to raise capital. During the book-building process, underwriter attempts to determine the price at which an IPO will be offered. Further, in the process of an IPO, institutional investors are commonly involved and are often considered as well-informed investors. Furthermore, the underwriter needs to create incentives for the institutional investor to reveal what price they are willing to pay to facilitate the process of correctly pricing the IPO shares.
Venture capitalists and private equity investors have increased their requirements to conduct due diligence and incorporate ESG aspects while evaluating prospective investments as ESG integrated funds remain relatively safeguarded. They want to know at early stage whether the company carries any sustainability risks that could negatively impact the value of the company. Largest investors worldwide are allocating capital to companies that are well equipped to benefit from the transition to a green & sustainable economy and are willing to protect their portfolios against downside ESG risks.
As part of Pre- IPO research and ESG assessment, companies should reassess existing models with objective of understanding its degree of sustainability, evaluate their performance in all material ESG aspects, devise strategy which is driven from top management, connected to company’s purpose that create and capture long term competitive advantage.
A company’s ability to create positive environmental and societal impact, is rapidly reshaping competitive advantage and companies must simultaneously integrate an ESG aspects into every component of the business to capture the value from this transformation.
To tap maximum responsible investors, companies need to broaden their outlook to consider ESG more than just compliance. For companies planning IPO, ESG is ‘pre-financial’ information rather than a ‘non-financial’ information and act as a listed company before going public.
(Author Rajib Debnath is Partner and co-author Neha Malhotra is Director – Sustainability & Developmental/CSR Services at Nangia Andersen LLP. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)