This is the first blog in our Private Equity series. Stay tuned for upcoming blogs on Scope 3 inventories and climate risk assessments for PE.
Inventories on portfolio companies
As climate change rises on the agenda for private equity, it is fast becoming an expectation that investors collect greenhouse gas (GHG) footprints, or inventories, on their portfolio companies. Both fund managers and portfolio companies are being asked for GHG emission data from stakeholders, but the inventory is also a critical first step to better manage climate risks and opportunities, and create a transition plan away from fossil fuels, which can future-proof and enhance the value of an organization. An inventory is the first step to carbon accountability.
Most immediately, private equity general partners (GPs) are experiencing direct pressure from limited partners (LPs) to provide portfolio-wide GHG emissions data. On the other hand, portfolio companies (PCs) are receiving increasingly forceful requests for this data from key customers, either directly or through sustainability disclosure platforms, such as CDP or EcoVadis.
There is also value in having mature carbon accounting practices at exit, be it to another private equity fund, a strategic buyer, or an IPO. GHG inventories provide meaningful data for buyers while robust GHG accounting processes will instill confidence in an organization’s ESG practices.
We seek to build a foundation of knowledge that helps companies appreciate the value of the inventory effort and meaningfully digest the results while considering future decarbonization strategies.
Obtaining a successful inventory
Many GPs are currently seeking inventory solutions for their own operations and their portfolio companies that appropriately balance efficiency, cost, and precision. Through our work supporting GPs and their PCs through the inventory process, we have identified three key practices that lead to successful GHG inventories:
Support throughout the process is critical: While an inventory for a portfolio company may often be “simpler” than one for a large public company, there are several dynamics at play for mid-market firms that should be front of mind.
- PCs often have limited resources to manage and maintain the GHG inventory. Assigned personnel may be balancing competing priorities.
- The PC resources supporting the inventory often do not have any experience in GHG management or accounting. Foundational concepts such as Scope 1, 2, and 3 are often foreign, and the entire exercise can feel esoteric and pointless. If these knowledge gaps are not properly addressed, they can lead to mistakes and cumbersome corrections.
- Especially if it is their first inventory, much of the data are often not tracked or difficult to get (e.g., leased facility where landlord pays the utilities).
For all these reasons, the success of a GHG inventory program often rests on effective support and guidance along the way. In our engagements with portfolio companies, we provide a package of trainings, guidance, and hands-on support that positions the PC for success.
A reliable inventory yields more value: It may be tempting to bootstrap an inventory to save cost and effort, e.g. through DIY excel-based calculators, directional estimates that don’t require activity data, or even low cost, off the shelf software tools. We have seen many requests for simple excel-based inventory calculators. But in our experience, these approaches lead to inaccurate results. Changes in emissions factors, lack of quality control on data inputs, unusual emissions sources, and a lack of access to knowledgeable experts can lead to errors. While a bootstrapped inventory could be reported to LPs without much consequence, it the work will not provide value for the PC or the GP beyond checking a box. To meaningfully understand GHG emission sources and address climate risks and opportunities, an accurate inventory is essential. For example, if a company wishes to set a carbon reduction goal, but the baseline inventory is off by 10%, this error could dwarf the ability to show reductions progress and create significant additional costs to demonstrably achieve the goal. In addition, regulatory requirements are tightening and inaccurate GHG reporting may result in costly consequences.
Think two steps ahead. A GHG inventory is just the beginning: While the critical need for many GPs today is to establish an inventory, the expectations from LPs and other stakeholders are steadily rising. It will become common practice for portfolio companies to set and then achieve carbon reduction goals. Meaningfully assessing and managing climate risk will also become mainstream. The inventory is the foundational first step to develop a broader climate agenda. We recommend taking a forward-looking approach that will position you and your portfolio companies well to evolve your practices and meet increasing expectations.
Please check out our greenhouse gas inventory solutions for private equity along with other climate-related offerings like goal setting, decarbonization strategy, and climate risk and opportunity assessments.