Genstar CFO Q&A: How to conduct ESG diligence and reporting

Melissa Dickerson goes in depth on how the firm runs and maintains its robust environmental, social and governance program.

Can you speak about what your firm is doing in terms of being more ESG-minded?

We’ve instituted a volunteer day where we try and help the community. For example, our last volunteer day we had a group of students from SEO (Students for Educational Opportunity) come into our offices and hear about private equity. This program takes kids from diverse and more challenging backgrounds and educates them on what private equity is and what career opportunities exist. If you can see it, you can be it, and the idea is to try and open the door for untapped potential. In addition, we went to the Presidio [a park in San Francisco] as a team and did some gardening.

In the office, we have tried to be more thoughtful about simple things like water consumption and staying away from plastic bottles. There are organizations like the UNPRI that really are trying to help general partners bring thought into action and give road maps and tools, so we’ve benefited a lot from that help from that organization in particular, just in our own ESG program and implementing it.

Did your firm do anything differently after the #MeToo movement started? Now that it’s a few years in, is there anything that you updated within your policies?

I don’t think we necessarily reacted, because we were already thinking about it. A culture that encourages collaboration, transparency and accountability is an important commitment we take seriously. We signed on with the UNPRI around March-May of 2015. We probably thought about ESG more in response to our European investors being thoughtful about it. Europe has done a good job of leading the way here. They’ve been thoughtful about global impact, not just diversity and inclusion, but data privacy. You’re seeing that now with the internet companies and some of the laws coming out of the EU and other areas of ESG. Historically, a good chunk of our investor base has always been from Europe, which was more of the tip of the spear in what led us to develop our program.

We always invested with a moral code. Creating a program helped us put what we were already doing into a different framework. Knowing whether an industrial company is a good actor or a bad actor before you start contemplating buying a company is good to know. Characterizing that action into our ESG framework is something that has been developing over time and now we just have a more formal way of reporting, monitoring and tracking it, which is great because it keeps you disciplined. I don’t necessarily think people weren’t being good actors. We know more now and, similar to climate change currently being top of mind, ESG issues will continue to evolve over time.

Can you speak to what that framework looks like?

We work with this great consultant group Malk Sustainability Partners. With their help, we worked with lots of investors to develop checklists and templates that are specific to different industries. So, if you’re looking at, for example, an industrial business, you’re going to be concerned with the outputs, the carbon impact, whatever they’re producing, the excess, the waste, the runoff, versus buying a services business. That’s more about people, making sales and potentially their office environment: is it green? Is there thought around the use of energy and plastic bottles and things like that? It’s going to be different for different industries, and again, it’s evolved to include lots of things like data privacy or diversity inclusion, board representation, etc.

We engage with Malk every time we are doing diligence on portfolio companies. They’ve assisted us with that analysis. They’ll talk to the management teams and look at the data rooms and give us an assessment, which we’ll then incorporate into our investment committee process. If there are already red flags, we’ll know about them before we buy a company. But it gives us a good baseline because if you do end up buying the company, this is where you start.

Annually, we re-engage Malk to conduct an annual monitoring process. Malk will review where we started with each company and look at how we are one, two and three years later. These issues are communicated to the portfolio company executive management team or relevant people there, because it might not necessarily be a CEO who is in charge of ESG on that portfolio company’s side; it might be the risk manager. We’ll also engage them upon exit so that we have a picture of the round trip during our hold period. This shows the kind of impact we might’ve had on the ESG paradigm from start to finish.

Do your ESG policies come up during fundraising?

They do, and being a signatory to the UNPRI, it’s on our website, so we have a responsible investment policy that is published on our website.

Do you feel like investors are asking about it more recently?

I do think that there’s a trend. I would say they’ve always asked about it. Now the ask has turned into questions like, “We’d really like to see these items as an annual update.” Or, because you usually have an annual meeting with your investors, they’ll say, “We want it on the agenda. Can you give us an update every quarter or year?” They kind of want that accountability, and they’re making some efforts around that, again, coming from Europe.

That’s the ESG reporting that you were speaking of?

Part of it is, and then we do more of a summary of it. I’ll incorporate it in our annual report so I can tag, specific to each company, the financial metrics and the ESG updates. I’ll just put it all together in our annual report, and then we might extrapolate some of that data if we get a request for an ESG diligence questionnaire. Another trend I’ve seen too is, again in Europe, people hiring ESG directors.

Can you give an example of an ESG update? Let’s say it’s a new quarter. What’s an update that you would be doing?

We’re long-term investors, and 2015-19, it’s not that long. So, for us the last report was, “Okay, we had a couple of investments. These are our first two full round trips since we implemented in 2015. Here’s how that evolution looked. From the start we identified these issues and at the end we re-mediated these issues, and this is where we ended up.” I know Malk was great in helping me analyze the trends from just year to year, for example, with the overall portfolio saying, okay, we identified that maybe four of six companies had to work on data privacy, for example. Then at the end of the year, of the six, five were successful in implementing what they needed to. That is a little bit of a taste of how that reporting works.

Who should be in charge of ESG? How do you make sure that your firm, your employees are following certain policies, and is there a training program involved?

What we have found successful is having the chief compliance officer oversee the program, because together with making sure the SEC program and the compliance program is adhered to, she can also ensure that the ESG program is adhered to. It’s change management if you think about it. Again, we’ve done it awhile now, so I think people know, “Okay, when I identify a company, we’re doing diligence. I’ve got to call Malk and make sure they’re in the data room.”

Carolyn [Greenwalt], our new chief compliance Officer, has been great and is continuing to oversee the program. She’ll continue to do that as time goes on. So she’ll be the one, for example, to onboard the new associates and ensure that they understand the playbook and understand who they should call to ensure that we’re getting ESG diligence accomplished, that it’s included in our investment memos, that that annual exercise is happening, that that communication between our portfolio companies, if it’s Malk or Genstar, is happening, and that everybody’s aware of the program and the findings and the baseline and the expectation.

I think it’s going to probably be a little bit different depending on the company. If you’re $200 million AUM versus a firm with billions of dollars of AUM who might have dedicated ESG resources, I would imagine you’re going to have one person who’s doing quite a bit at a $200 million AUM firm.