In some ways simple, in others complicated. The unique challenges of carbon accounting for investors.
In the context of new regulation and increasing demand from LPs, VC and PE firms are busy developing their ESG credentials. Moreover, the “E” is central: as a key global challenge, with metrics that are possible to quantify and improve over time, action on carbon is the focus.
So how can VC and PE firms properly and compliantly account for their carbon impact and satisfy their LPs?
At Seedling, we’re dedicated to unlocking the potential of the investor industry to influence climate change, making it as easy as possible for investors to measure, track and report on their emissions accurately and compliantly. Read on to find out how we do it.
In one sense, footprinting for investors is straightforward. Without any complicated manufacturing processes or large vehicle fleets, their day-to-day operation emissions consist primarily of:
- Office-related emissions (heating, electricity).
- Travel (commuting, attending meetings and events).
- Procurement (laptops, phones, professional services).
In other words, no different to a typical office-based service business.
However, in another sense, they are amongst the most complicated. The reason is simple: their portfolio companies count. In a properly-conducted, fully-compliant carbon footprint, a VC or PE firm’s portfolio companies contribute to their total emissions – and almost certainly constitute the vast majority of the firm’s total carbon footprint.
But if portfolio companies are separate entities to the GP, with a clearly distinct operational footprint, why should they count?
The fundamental principle is that the investment decisions of VC and PE firms have downstream implications for carbon emissions – and this matters for carbon accounting. As an analogy, consider purchasing a new laptop: your decision facilitates emissions (from the production of the laptop), and these contribute to your overall carbon footprint. In the same way, investing in a company facilitates (indeed, finances) emission-generating activity that may otherwise not occur. Therefore, like the laptop, those emissions count.
And because VC and PE firms are operationally light – but high-impact in facilitating (emission-generating) commercial activity – their portfolio emissions typically dwarf their operational emissions. In short, if portfolio companies are ignored, a fund’s carbon footprint remains incomplete.
So how, exactly, should VC and PE firms measure the emissions of multiple diverse portfolio companies? And how do those emissions contribute to their overall footprint?
The ideal scenario is that every portfolio is already measuring and tracking their carbon footprint, in full compliance with the GHG Protocol (the gold standard for corporate carbon accounting). However, very few investors are in this position. While carbon accounting has become well-established (and indeed mandatory to some extent) for large corporates, it remains in its infancy amongst startups and mid-market firms. According to one survey of VC funds, only 11% of portfolio companies have completed a carbon footprint. This is mainly due to the difficulty, cost and time required to do so, particularly for smaller companies – problems that Seedling is dedicated to solving.
Where portfolio companies have not yet completed a carbon footprint, it’s best practice for investors to encourage them to do so. As well as generating more accurate data for the investor, it’s good for the planet: it will help more companies to track and reduce their emissions over time. But some investors have a more hands-off approach. How can they make sure all of their portfolio companies are included?
In this case, it’s possible to estimate the emissions of portfolio companies using an industry-based estimation model. The simplest approach is to use a so-called environmentally-extended input-output (EEIO) table. This takes the revenue of a company (in £ or $) and converts this into emissions based on the company’s broad industry sector (e.g. financial services, technology). However, this provides a very high-level indication of a company’s total emissions only. The available categories are relatively broad and there is no breakdown by emission type. Seedling has a developed a more granular estimation model, based on 4 simple questions, which:
- Uses employee numbers rather than revenue (a more accurate metric for smaller, growing companies).
- Accounts for ~700 different commercial activities (based on the 5-digit SIC code classification).
- Breaks emissions down into Scopes 1, 2 and 3 (based on the GHG Protocol).
Once you’ve got an idea of your portfolio companies’ emissions, how exactly should you aggregate and attribute them to your own footprint?
The GHG Protocol, while useful for most businesses, has not been formulated with investors in mind. It has clear enough guidance on how to account for:
- Other entities in which you have a financial interest.
- Investments you make on behalf of other parties.
But not on how exactly to manage the unique, nuanced combination of the two which characterises VC and PE firms.
Therefore, industry-specific guidance, although in its nascency, is key. The Initiative Climat International (iCI), an international, investor-led climate change initiative, has published an excellent first draft of an investor-specific carbon accounting standard. As a comprehensive guide, it aims to standardise how investors account for both their operational and portfolio-based emissions. It follows the GHG Protocol and draws heavily on the Principles for Carbon Accounting Financials (PCAF), a broader standard for the financial services industry at large. To summarise its key tenets in relation to portfolio emissions:
- Portfolio emissions should be counted as a “downstream” Scope 3 emission. In short, part of an investor’s value chain impact, rather than a core feature of their own operations.
- These should be attributed to the investor based on the value of equity (and debt) invested in each company, divided by the company’s total equity (and debt). These attributed emissions are known as “financed” emissions.
- Companies should only be counted if they were a live investment for the full 12-month carbon accounting period (i.e. any mid-year investments/exits should be excluded).
- A portfolio company’s emissions should be based on their most recent 12 months of emissions data, even if (inevitably) this does not fully align to the investor’s accounting period.
- Accuracy matters. Each portfolio company is assigned a score of 1-5 depending on the methodology used to conduct the assessment. This is aggregated across an investor’s funds/full portfolio to provide a data score which, ideally, will improve over time as more companies commit to full and compliant carbon footprinting.
While this standard is likely to be clarified and developed further in the coming years, it is an important first step to standardising carbon accounting for investors, incentivising the industry to gather better, more accurate, most consistent data. Given its potential to make the VC and PE system greener, many industry associations, such as the BVCA, have endorsed the standard and begun to encourage its use.
Our dedicated VC/PE product, seedlingInvest, is the first carbon accounting software on the market to fully align to the new standard. We make it as easy as possible for investors to measure, track and report on both their operational emissions and their portfolio emissions. Our approach is flexible: invite companies to the platform to complete an assessment, use our emissions estimation model, or simply input data from assessments already completed by the business. You can also view the climate action of your portfolio companies (e.g. Net Zero targets, carbon offsetting) in one place.
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