[EBN Column] Startups in the ESG Era (2/2)
Lee Jong-ik, CEO of Korea Social Investment
There are many prospects that this winter will be an unusually cold winter for startups. The future value of companies that have recently been invested in or confirmed is forming up to 50% lower than in the past (1-2 years ago). Accordingly, companies are also suspending investment rounds, delaying the timing, or lowering the amount of investment requests. Sometimes, the enterprise value is equal to or reduced from the previous round of investment.
This can be said to be largely attributable to the contraction of global supply chains and shrinking consumption due to the global economic recession and inflation. From an investor's point of view, it can be attributed to three main factors. First is the reduction of investment funds. In particular, investment resources from conservative private financial institutions, conglomerates, and venture capital (VC) are rapidly declining. As investment resources are reduced and the size of the fund is reduced, the selection of target companies and investment decisions are made very conservatively.
The second is the conservative evaluation trend of the valuation index. Price Earnings Ratio (PER), which is calculated based on sales and operating profit, which are major factors in evaluating corporate value, and EV/EBITDA (Enterprise Value/Earnings before interest, taxes, depreciation and amortization) is underestimated. Investors are judging that the future expected sales and operating profit claimed by the company will be reduced.
Third, it reflects the internal rate of return (IRR) of the investment target company by raising it. It is judged that the probability of investment failure in startups is higher than in the past, and for this reason, IRR must be raised to maintain the average expected rate of return of investors. In addition, discount rates are also reflected in the process of calculating IRR. This, in turn, has the effect of lowering the corporate value of startups.
It is difficult to predict how long this situation will last, but what is clear is that the target for investment is narrowing. Due to investors' selection and concentration strategies, more investment is concentrated in companies with high growth potential and market dominance, while companies that do not have the ability to dominate the market are unable to seize investment opportunities at all. However, it is noteworthy that even in the midst of this, ESG-based startups are receiving steady attention.
Despite the worldwide logistics imbalance and energy crisis caused by the Ukraine-Russia war and COVID-19, laws and regulations related to carbon neutrality for the future sustainability of the earth continue to expand. In addition, a new capitalist paradigm called stakeholder capitalism is becoming mainstream. As a result, investments in ESG-based companies by leading global investment institutions are exploding.
ESG venture funds or ESG ETFs, which are already directly or indirectly invested in ESG companies, are emerging as mainstream in advanced markets such as Korea, the United States, and Europe. Korea has a high ETF ratio like the United States, but recently, private funds, including the government's ESG fund, are also actively being created. In my last article, I mentioned that the ESG guidelines for venture investment will become the standard for ESG venture investment. However, fund management companies are already evaluating the ESG value and capabilities of investment target companies based on various criteria, grading them for investment, and using them as a benchmark for investment.
There are no unified ESG evaluation standards and scales in Korea yet. Domestic evaluation agencies refer to the items of various global ESG and sustainability management evaluation agencies. In addition, the government's K-ESG guidelines (2021.12), SME ESG checklist (2021.1), and venture/startup investment standards (2022.7) are mainly used. Not all startups need to prepare for ESG evaluation, but companies planning to attract investment in the future should pay attention to the ESG evaluation criteria and prepare step by step.
Then, how should startups respond to the ESG management environment? In summary, the main contents are as follows.
1) ESG mission/management strategy establishment or advancement
2) Development and operation of business models, profit models, products/services tailored to ESG strategies,
3) KPI setting, monitoring and reporting
ESG management response is not something that can be solved by changing some products or services or creating a dedicated organization. All management elements must be integrated and operated consistently under the ESG management foundation.
First of all, you need to make sure that your company's purpose is aligned with ESG. The mission and vision (periodic goals), which are the purpose of the startup business, must be clearly established. There is a startup called bluereo that developed the world's first sonic toothbrush with a suction function that sucks brushing water. bluereo's core corporate value is "honest and sincere interest in the happy daily life of people who are unable to act on their own."
Under these values, bluereo continues to release innovative technology products that help hygiene oral care for the disabled, patients, infants, and the elderly who suffer from inability to spit out brushing water on their own. It also helps people around the world with the same problem with important daily activities. bluereo's business strategy is also being prepared in line with this ESG mission. The manufacturing process, parts use, and partner transaction policies are also operated under ESG, which differentiates them from general commercial companies.
Once a strategy is established, business models (profit models), products, and services that fit the strategy must be consistently developed and operated. The same applies to products and services that use advanced technology. We would also like to introduce Seed&, which makes deep-tech technology products that minimize energy use while keeping indoor spaces healthy and comfortable. Seed&'s products use real-time weather data and IoT sensors to provide customers with solutions that automatically control indoor air conditioning and air conditioners based on AI technology.
Pixelo, which aims to improve the quality of life of the elderly and the sight-impaired, is also a representative ESG startup. Pixelo provides products and services such as a blue light blocking filter, a digital eye care inner eye app, and a vision protection/correction/presbyopia prevention film called Vivid Film. Pixelo is consistently making software and hardware products for healthy eyes and vision improvement, and based on this success, it is positioning itself as a representative solution company for the sight-impaired people around the world.
The third important element of ESG management is the establishment and management of key management items (KPI). ESG startups should set KPIs that fit the company's ESG mission, strategy, and operations. Established KPIs are periodically monitored, and the results must be transparently disclosed to all stakeholders of the company. Introducing Mubang, another representative ESG startup. Mubang provides products and services that solve the youth housing problem by eliminating monthly rent deposits. Musang's ESG KPIs are clear. Not only the number of young members using the free service, but also the amount of deposit deletion, the number of brokerage cases, the contract renewal rate, and landlord/tenant satisfaction are managed as KPIs.
Craypas Solution, which increases the convenience of financial transactions for thin filers and medium credit users with no or little financial transaction records, is also an ESG company to note. Craypas accurately evaluates various big data (non-financial data such as purchase records and communication records) with AI-based technology and uses it as credit data. This technology is positioned as an alternative credit evaluation that changes the paradigm of existing credit evaluation based only on financial history. Craypas' KPI is very advanced. In addition to direct factors such as the number of customers and transaction amount, indirect factors such as personal credit rating improved through service, reduction in financial expenses, and reduction in credit cost of financial institutions are also managed.
On September 14, 2022, Yvon Chouinard, the founder of Patagonia, a leading ESG company, and his family made a surprising press announcement. It announced that it would donate 100% of its shares (market value of 4.2 trillion won) to non-profit organizations for environmental protection.
In addition, the company decided to use all of its brand income, which amounts to 140 billion won annually, for climate change and environmental protection activities. In this time when ESG futility comes out due to the difficult economic situation around the world, the announcement of Yvon can be said to have a very large implication for us. ESG is not only applicable to global giants or domestic conglomerates. Even for startups, ESG is a must, not an option.