Gearing Up for an IPO? Make ESG Part of the Equation
Going public invites heightened scrutiny on the way company leadership teams manage non-financial issues. Making ESG part of the IPO readiness plan can help increase valuations and guard against threats to IPO success.
Over the past year, uncertain markets have contributed to a decline in the number of companies going public. While new initial public offerings (IPOs) average about $228 billion annually, they only raised $154 billion in 2022. Traditional economic and financial factors have long played the leading role in determining an IPO’s strategy, timing, and ultimate success; however, companies’ environmental, social, and governance (ESG) strategy and disclosures are increasingly relevant as investors demand more of this information.
For investors, the importance of ESG is not new, but newly public companies now face the need to have meaningful ESG programs and disclosures.
In fact, environmental, social, and governance investing (ESG) is projected to generate $53 trillion in assets under management (AUM) by 2025, representing more than 30% of the projected $140 trillion in global AUM. With this in mind, savvy CFOs planning an IPO want to work closely with their ESG or sustainability reporting specialists to take a pulse on what their company is doing right, and identify any problem areas before opening up the company for public ownership. Since accounting and SEC reporting teams are usually involved in ESG reporting efforts, the office of the CFO is the ideal place to kick off efforts to develop comprehensive ESG reporting. Doing so can boost valuations by meeting investors’ needs for more non-financial disclosure.
ESG can be a significant contributor to IPO success
In many cases, ESG is proving to be a scale tipper with a significant impact on the IPO process. The Mediterranean-style restaurant chain CAVA Group, Inc. offers a case in point. In its New York Stock Exchange debut, CAVA was valued at $4.88 billion — 117% above the initial value of $2.45 billion.
Why the huge jump? ESG played a key role. Pre-IPO, Credit Suisse recognized the strength of CAVA’s ESG program and noted, “[CAVA’s] ESG initiatives are critical to its strategy across the supply chain, people, and the environment, highlighting consumers are increasingly seeking to engage with brands that align with their values. CAVA suggested its vertically integrated supply chain allows for increased efforts around sustainable operations.”
While CAVA is not ready to publish a nearly 50-page impact report like its competitor, Sweetgreen, it has established an oversight apparatus for corporate ESG, enabling the development of a meaningful program. The company entered the public domain with a robust ESG foundation, including a 43% female senior leadership team and two specialized board committees: the People, Culture, and Compensation Committee and the Nominating, Governance, and Sustainability Committee, which assesses the company’s “sustainability and ESG-related policies and programs against its key related objectives,” tying together CAVA’s mission to “bring heart, health, and humanity to food.”
While ESG practices alone will not drive valuation, there is little doubt that the company’s practices have helped it gain visibility with investors and insulate its stock against heightened scrutiny in public markets.
Explore 3 reasons why ESG is more important than ever in IPOs
The importance of ESG risks and opportunities to investors is not new, but the expectation for newly public companies to have meaningful ESG programs and disclosures is. These heightened expectations are primarily driven by three precipitating factors:
- The average institutional investor has matured in assessing ESG risk over the last few years. Large investment managers no longer depend on ESG rating agencies like MSCI or Sustainalytics to tell them who performs well; instead, they’ve developed their own risk frameworks and assessment models, using the rating agencies as additional data sources. This means that investors are as capable as ever in evaluating ESG-related risk, and they’re understandably averse to establishing a position in a company that has no program to mitigate or minimize those risks.
- Employees, customers, and vendors are more vocal in their demand for companies to establish ESG-related programs and goals. ESG can help a newly public company establish its identity with consumers, attract talent, and retain employees. For instance, surveys by IBM and Society for Human Resource Management (SHRM) have found that half of consumers are willing to pay a premium for sustainable brands, and more than 60% of executives claim ESG programs have positively impacted employee recruitment or retention. At the same time, vendors are increasingly asking companies to complete EcoVadis or CDP assessments because of stakeholder prioritization of ESG.
- The long-anticipated SEC climate risk rule will necessitate a baseline environmental sustainability program in every publicly traded company in the United States. Once the SEC rule is in place, it seems newly public companies will not be afforded an exceptional grace period or runway to develop their climate risk programs and disclosures. Instead, companies must have the appropriate policies, protocols, and reporting in place upon going public. This will create a whole new barrier to going public in US markets.
What’s at stake for companies that overlook ESG risk?
A recent study revealed that 89% of investors consider ESG issues in some form as part of their investment approach. Opening the company to the public includes onboarding shareholders with specific agendas and standards of corporate governance. Going public with a good ESG foundation is not only a good offense when it comes to attracting stakeholders of all types but is also a great defense.
One immediate risk for unprepared companies is investor activism. A lack of ESG reporting and/or oversight provides ammunition to activists who may garner the support of large institutional shareholders to challenge the board with alternative nominees. Another risk of forgoing baseline disclosures is exclusion from specific passive indices aligned to ESG ratings. Finally, companies can be disregarded by suppliers, customers, or advertisers, which is no way to start a new chapter in the public domain.
How can IPO candidates ensure ESG readiness?
The specific ESG expectations and prerequisites will vary on a company-by-company basis depending on numerous factors ranging from industry to market cap to physical impact. However, all companies preparing for an IPO can benefit from adopting a series of baseline ESG activities and disclosures. Taking these steps creates an ESG foundation that will help check many of the right boxes before going public:
- Start by outlining ESG goals that align with the company’s business strategy and growth trajectory—CFOs in particular can lean on resource efficiency as a tool to achieve cost savings. Then, learn what factors are top of mind for investors and rating agencies for the company’s industry.
- With the goals outlined, develop policies and statements on critical topics such as environmental impact, human rights, data privacy, and human capital.
- Establish board-level oversight for ESG-related risks, including climate, human capital, and cybersecurity. This signals that ESG is receiving appropriate attention and prioritization from the highest levels of the organization.
- Develop internal controls to streamline and standardize the data collection process for ESG-related data. This step, led by the controllership, prepares the company to report consistent data that is SEC-compliant.
Make sure ESG is on the IPO preparation timeline
Establishing an ESG program has become table stakes for companies planning to go public. Real financial and time investments are required for firms starting from scratch, but effective leaders who focus on the most relevant ESG topics and initiatives avoid overcommitting or overspending.
This Insights article is one in a series providing capital markets commentary for CFOs with a focus on IPO best practices. Learn more with timely and relevant analysis about readying your company for IPO success and the key process and technology-focused considerations when taking your company public.
Need help to flag ESG challenges ahead of an IPO?
Riveron supports pre-IPO companies in navigating today’s multifaceted challenges. As part of our cross-functional expertise, we focus on equipping ESG professionals and financial reporting teams to make strides before, during, and after going public. Reach out to Riveron’s integrated ESG team to help build your audit-ready ESG reporting plan.