Does ESG Impact Valuation? Answering the Most Common Questions About IPO ESG Assessments

Posted on August 11, 2022

Curtis File
Curtis File
Writer, Corporate ESG

Why should environmental, social, and governance (ESG) issues be incorporated into my company's IPO? As companies working toward an IPO increasingly acknowledge the need for an ESG strategy, this question is typically the first of many. Other common queries revolve around the preparation for an IPO ESG assessment, what the various stages of the process are like, and what happens after an assessment and final report is delivered. This FAQ provides the answers.  

Do I need to incorporate ESG considerations into my company’s IPO? 

Incorporating ESG issues is as important at a pre-IPO stage as other factors that matter to a company planning to list on a stock exchange. Thoughtful consideration of your company's ESG issues can help attract investors and investment funds, help build credibility, and offer the market some indications of your company's competitiveness. A comprehensive ESG strategy can pique investor interest by showing them your company has a long-term plan for success. It also builds trust in the market by showing investors and potential clients alike that you are transparent about your ESG plans and activities. 

Although IPO ESG assessments may not be legal requirements, they are increasingly important.1 An IPO ESG assessment by a credible third party serves as a supplement to a company’s final prospectus and intention to float (ITF) announcement. It rates private companies as if they are already public and is forward-looking to the company's post-IPO state.  

What is an ESG rating? 

ESG ratings are a consistent, streamlined, industry-recognized way to quantify and evaluate how much of a pre-IPO company’s business is at risk due to ESG factors. Sustainalytics’ ESG Risk Ratings consist of three building blocks — corporate governance, material ESG issues, and idiosyncratic ESG issues — which help determine the magnitude of a company’s managed and unmanaged ESG risks. 

How can having an ESG rating influence investors? 

A report by Morningstar showed that 57% of the firm’s ESG indexes outperformed comparable non-ESG indexes, while 80% of companies in ESG indexes outperformed their non-ESG counterparts over a five-year period.2 Data like this are compelling investors to increasingly look at ESG ratings and other related metrics when evaluating a company before an IPO. Having a plan to manage ESG issues and disclosures can help build trust with investors and demonstrate that you are prepared to handle potential risks to your business.

For example, an AI start-up with a clear plan for handling data privacy and security issues is likely to attract more investor interest than a competitor with no such plan. Looked at from this perspective, managing ESG issues and disclosures can affect everything from pre-IPO fundraising and valuation, to how a company builds market credibility. 

What is the connection between corporate governance and ESG ratings? 

Corporate governance refers to the system of rules, practices, and processes by which firms are directed and controlled. It also involves balancing the interests of a company's stakeholders that may include shareholders, senior management, customers, financiers, and the community. Corporate governance is a foundational element of the ESG Risk Rating. It applies to all companies regardless of their industry, product, or subindustry, and makes up approximately one-fifth of an ESG Risk Rating, with slight variation from company to company, based on the type of risk and nature of their business. An IPO ESG assessment evaluates resources and documents related to corporate governance to generate a report on exposure to ESG risks. This helps investors better understand if a company’s IPO is a smart, long-term investment. 

How do Material ESG Issues (MEI) impact ESG ratings? 

Material ESG issues (MEI) focus on topics that require a common set of management initiatives or similar types of oversight, including human capital issues such as employee recruitment, diversity, development, labor relations, and engagement. They are based on the typical business model and business environment a company is operating in. They are at the core of ESG Risk Ratings because they can influence a company's economic value. An IPO ESG assessment also helps pre-IPO companies identify any potential Material ESG Issues that can affect their long-term business goals. 

How is an IPO ESG assessment derived? 

An IPO ESG assessment is derived from a combination of publicly available disclosures and details provided by a company. These include:  

  • The company's latest fiscal year’s disclosure related to environmental and social policies and programs. 

  • The company’s prospectus detailing its corporate governance (CG) practices and policies. 

  • An evaluation of six corporate governance pillars typically applied to listed companies: Board and management quality and integrity; board structure; ownership and shareholder rights; remuneration; financial reporting; and stakeholder governance. 

Documents and resources provided by a company become the basis for an IPO ESG assessment of its exposure to ESG risks. This report can then be used by investors and firms to understand how a company manages its exposure, and whether its IPO is a smart investment. 

What are the requirements for documentation used in an IPO ESG assessment? 

All documentation used to generate an IPO ESG assessment needs to meet the following criteria:  

  • It must be authentic, with company name and logo, date stamp and review date. 

  • It must be credible, with details of corporate programs and governance policies, initiatives, or practices that are fully implemented. 

  • It must be public, publicly available, or publicly disclosable. 

  • It must be final, because documentation that has already been submitted cannot be changed or updated. 

Read our latest ebook for answers to more questions related to an IPO ESG assessment. Find out why ESG should be incorporated into an IPO, how your company can prepare for an assessment, every stage of the pre-IPO research process, and what happens after an assessment has been delivered. 

 


References

1 The IPO ESG assessment uses ESG Risk Rating methodologies and provides insight into your company’s ESG risk by measuring unmanaged risk. This risk is measured by MEIs, which, as noted above, have a potentially substantial impact on a company’s economic value. 

2 Ng, M. 2022. “ESG indexes outperform their non-ESG equivalents.” Fund Selector Asia. August 10, 2022. https://fundselectorasia.com/esg-indexes-outperform-their-non-esg-equivalents/

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