VIEWPOINT

2024

UNLOCKINGS U S TA I N A B I L I T Y VA L U E
I N P R I VAT E E Q U I T Y
A new tool to move beyond
identifying red flags

AUTHORS
Florent Nanse

Private equity (PE) is leaving billions of dollars

Julien Marchesein sustainability value on the table. While someAlan Martinovich

practitioners focus on the value proposition ofsustainability, the current status leaves much to
be desired. Gaps in current approaches include
cumbersome frameworks focused on risk compliance

Sean McDevitt
Tensie Whelan, NYU Stern
School of Businessrather than value creation, difficulty capturing thefinancial benefits of a sustainability strategy, lackof clarity around which KPIs to track, and significant
communication issues between general partners(GPs) and limited partners (LPs). This Viewpoint
introduces a powerful tool to better identify value
creation and risk-mitigating opportunities at thedue diligence and early holding phases.

IN PARTNERSHIP WITH:

ARTHUR D. LITTLE

VIEWPOINT

Between 2010 and 2022, assets undermanagement of PE more than quadrupled. As
the PE industry continues to expand, there is a
growing opportunity to generate financial andsocietal value through sustainability initiatives.
Increasing the availability of finance is also a key
lever to move the industry toward net zero goals;
for example, according to BloombergNEF, only
about 16% of climate finance needs are currently
being met. Because PE firms often hold majority
control over their portfolio companies, they wield
considerable power to implement sustainability
initiatives across a wide swath of industries atthe portfolio company level.

About the research
NYU Stern CSB, in collaboration with ADL,
conducted a research program aimed at
facilitating the PE industry’s transition
toward sustainable investing practices.
The scope included the identificationof the issues and barriers as well as thedevelopment of a new framework tooland guide to embedding sustainability
within portfolio companies. The research
included 40+ interviews with GPs, LPs,
and other stakeholders, alongside several
webinars with hundreds of practitioners. A

However, many PE firms are currently poorly

working group of five GPs applied firsthandidentifying and capturing sustainability value.

experience to help develop the tool,

Based on new research by the New York University

ensuring its practicality and effectiveness.

Stern Center for Sustainable Business (NYU

An additional 10 GPs tested the tool to

Stern CSB) in collaboration with Arthur D. Little

provide feedback before finalization.

(ADL), we know that most GPs tend to focus on
identifying red flags during due diligence (with a
few leading exceptions, especially in Europe) but
rarely look into sustainability value creation. Afterpurchase, GPs may track a few environmental,social, and governance (ESG) reporting metrics
but often do not implement sustainability value
creation plans.

- Deal-sourcing/pre-due diligence phase.
Current practice focuses on ESG data

requests, checking against general exclusions,and often applying a gating methodology
based on specific criteria (e.g., an impact
investor might use criteria focused on qualityjobs). This type of approach may be adequate

This Viewpoint outlines a new tool (open source

for the pre-phase, although knowing how

and available free of charge) developed jointly

much depth to aim for can still be difficult.

by NYU Stern CSB and ADL to help GPs better
identify and capture sustainability value, bothat the due diligence phase and during the firstfew months of the holding period.

OPP OR TUNITIESFOR IMPROVEMENT
The research identified several clear
opportunities for improvement in how GPs
approach sustainability during the investment
lifecycle. Underlying these opportunities is thebasic premise that GPs still tend to approachsustainability as primarily a reporting issue rather
than a potential driver of value during each stage:

UNLOCKING SUSTAINABILITY VALUE IN PRIVATE EQUITY- Due diligence phase. This typically involves
reviewing material issues, including ESG

KPIs if available and an ESG scorecard. ESG
sensitivities may be applied to valuation
analyses to reflect possible impacts. The
main shortcomings are an emphasis on
red flag downside risks, superficiality inunderstanding the full extent of ESG issues,lack of data (especially for small and mediumsized enterprises), and limited or no focus
on upside opportunities from sustainability(e.g., the financial upside of mitigating risks
that may drive improved performance or
how sustainability investments could build
competitive advantage).

2

ARTHUR D. LITTLE

VIEWPOINT- Early investment and holding phase. Current

This enables better monetization of sustainability

common practice includes conducting a basic

benefits and the development of a stronger

ESG materiality assessment, tracking somesustainability narrative over time, grounded in

ESG KPIs, putting in place ESG accountability

real data. Striking a balance between short-term

structures, and creating annual sustainability

efficiency gains and sustained revenue growth isreports. However, there is often a lackcrucial. GPs must ensure the long-term viabilityof understanding of which ESG KPIs andof assets rather than short-term value extraction.

sustainability levers to focus on. There can beTargeted sustainability strategies can unlock

an emphasis on process, rather than outcome

value, drive top-line growth, and proactively

and metrics, without enough attention given

address material issues to prevent future

to return on sustainability investment (ROSI)

value erosion. Both the due diligence and earlyand value creation. GPs may conduct a basic

holding phases are important for realizing these

ESG materiality assessment and track a few

opportunities.

reporting metrics but often do not progress

NE W TOOL TO HELP UNLOCKSUS TAINABILIT Y VALUE

these further. ESG reporting metrics typicallyfocus on the output or existence of a policy
rather than the outcome or underlying
performance (e.g., “check-the-box” reporting).

In our research, many GPs confirmed that

- Exit. At the exit stage, the lack of effective

sustainability practices can derive more value,
provided they have the right tools. NYU Stern CSB,

ESG metrics and data means that value growthwith ADL support, has developed a practical tooland ROSI achieved are hard to demonstrate.

to address these needs across the due diligence

Research indicates that there is some upliftand early holding periods (see Figure 1):

in the valuations of companies that implement- Phase 1 — due diligence. The tool helps

strong sustainability practices, so investors
might be missing out on higher valuations.

conduct a high-level assessment of ESG-

GPs reported that investors are asking for

related risks and opportunities, offering

sustainability narratives at exit, but GPs

insights into potential financial improvements

currently lack the underlying data to validate

as well as red flags.

- Phase 2 — early holding period. Tailoredthese narratives.
So there are significant opportunities forfor the first 100 days of managing a newly

improvement in terms of better identifying

acquired portfolio company, the tool enables

sustainability benefits as well as risks,

GPs to analyze and prioritize material

understanding and prioritizing material issues,

issues and strategies and develop specific,

and adopting more performance-based KPIs.

performance-based KPIs through a more

Figure 1. Sustainability value tool

extensive analysis.

Figure 1. Sustainability value tool
PHASE 1 — due diligence
1
Target & sector
identification2

3

Auto-populated
buckets

Assessment oftarget company

PHASE 2 — early holding period
45Rating6
Issueprioritization

KPI development

7
Strategydevelopment

Source: Arthur D. Little

UNLOCKING SUSTAINABILITY VALUE IN PRIVATE EQUITY

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ARTHUR D. LITTLE

VIEWPOINT

How the tool works: Phase 1 due diligence

By way of output, the tool provides a summary heat
map that clearly shows areas with the highest

Figure 2 summarizes the modus operandi ofrisks, as well as those with the potential for value

the tool for the due diligence phase. The purpose

enhancement (see Figure 3). Initial feedback fromof the tool for this phase is to help the user focus

GPs indicated an appreciation for the efficiency ofon those sustainability issues and strategies thatthe tool, especially given the tight time constraints

are of greatest importance and relevance for theduring the due diligence period.

company being assessed. Once the user inputs
the sector, the tool automatically identifies:

How the tool works:- The most relevant material issues for thePhase 2 early holding period

sector, as defined by the Sustainability

Figure 4 summarizes the modus operandi of

Accounting Standards Board (SASB)

the tool for the early holding period phase. The- Good practice strategies, practices,

purpose of the tool for the early holding period

and value drivers (defined by NYU Stern CSB)

(e.g., the first 100 days) is to help the GP identify

With this as guidance, the user briefly researches

and further explore top-priority issues based oneach material issue, specifically looking at

downside risk and upside value potential, develop

stated commitments and progress toward thesethe most effective KPIs and strategies, and easily

commitments. Finally, the user assesses thecreate a full record of sustainability progress.

target’s performance on each material issue acrossConducting this analysis promptly at the start

six criteria by assigning a score of one to fiveof the holding period allows the GP to begin

for each. The criteria comprise current progress

tracking ESG and ROSI KPIs from the beginning,

versus commitments and targets, innovation

allowing the creation of a record of sustainability

and growth, risk mitigation, reporting standards,

improvement over the lifetime of the holding.

and management capabilities. The tool provides

Thus, at exit, the GP can more easily demonstrate

word models to help the user decide which scorea sustainable growth story.

to assign and recommended weightings for eachcriterion that the user can modify, if needed.

Figure 2. How phase 1 due diligence tool works
Figure 2. How phase 1 due diligence tool works

User identifies sector of target company

Auto-populated
buckets

Tool identifies most relevant material issues for the sector, then indicatesmitigating or value-adding strategies & underlying practices/value drivers
Material issues(defined by SASB)•

Energy management

Strategies•

Improving energy efficiency& use of renewables

Practices••

Adopt products, services& processes that use
less energy
Convert energy purchase(or generation) to
renewables where possible

Assessment oftarget company

User assesses how target company currently responds to material issues& related strategies, stated commitments, & progress toward commitments

RatingUser assigns scores
1-5 across 6 criteria

Current
progress

Cleartargets

Innovation& growth

Risk
mitigation

Value drivers•••

Lower energy costs
Reduced exposure toenergy-cost volatility
or grid breakdowns
Reduced regulatory
fines/risks

Crediblereportingstandards

ExampleTarget & sector
identification

Mgmt./org.
capabilities

Outputs: most relevant material issues, strategies, practices & value drivers,
including heat map to show priorities

Source: Arthur D. Little

Source: Arthur D. Little
UNLOCKING SUSTAINABILITY VALUE IN PRIVATE EQUITY

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ARTHUR D. LITTLE

VIEWPOINT

Figure 3. Heat map output from phase 1 due diligence tool
Figure 3. Heat map output from phase 1 due diligence tool
ILLUSTRATIVE
MATERIAL ISSUESSTRATEGY

Product design& lifecycle
management (1/2)

Adopting sustainable
packaging solutions

Employee health& safety

Protecting employee
health & safety

Waste & hazardous
materials mgmt. (2/2)

Committing to zerowaste to landfill

GHG emissions

Mitigating climatechange impacts

Water & wastewater
mgmt.

Improving water
security

Energy mgmt,

Improving energy
efficiency & useof renewables

Customer welfare

Waste & hazardous
materials mgmt. (1/2)

Current
progress

Cleartargets

Innovation& growth

Risk
mitigation

Crediblereportingstandards

Mgmt./
board/org.
capabilities

Total(weighted)

3

4

4

4

3

3

3.6

•
•
•

Reduced regulatory risk
Reduced material & input costs
Improved market share, loyalty, premium

3

3

3

3

4

3

3.1

•
•
•
•
•

Increased productivity
Increased retention
Reduced absenteeism
Reduced workplace insurance costs
Ability to hire the best

3

3

3

3

3

3

3

•
•
•

Operational efficiencies in reduced waste costs
Reduced regulatory risks
Innovation

1

3

2

2

3

2

2.1

•
•
•
•
•

Operational efficiencies in terms of costs
Reduced exposure to regulatory fines & fees
Reduced reputational & market risk
Lower cost of capital
Improved employee recruitment & retention

•
2

2

2

2

2

2

2

Ensure ongoing access to water(no stranded asset)
Reduced water use & wastewater disposal costs
Reduced regulatory & license to operate risk

1

2

2

2

3

2

1.9

Protecting customer
health & welfare
Reducing use ofharmful chemicals

VALUE DRIVERS

•
•
•
•
•

2

1

3

2

1

2

1.9

1

1

1

1

1

1

1

Lower energy costs
Reduced exposure to energy cost volatility
or grid breakdowns
Reduced regulatory fines & risks•

Increased sales/loyalty from changing
consumer demand
Reduced regulatory & reputational risk

•
•
•
•

Reduced chemical costs
Reduced regulatory risk
Reduced negative health incidents
Potential reduction of lawsuits•

Source: Arthur D. Little

Figure 4. How phase 2 early holding period tool works
Source: Arthur D. Little

Figure 4. How phase 2 early holding period tool works

DOWNSIDE

Issue
prioritization

User assigns scores against
more in-depth downside& upside criteria

Marketrisk

Regulatory
risk

Physicalrisk

Geopoliticalrisk

UPSIDE
Revenue growth potential
Operational efficiency
Reputation/multiple impact

OTHER
Investment/
effort required
for successful
execution

Outputs: more detailed heat map, scatterplots showing upsides vs. downsides

KPI development

User prioritizes top 3-5 issues/strategies & develops related ESG & ROSI KPIs foreach strategy, based on extensive NYU Stern CSB guidance & KPI database built into tool

Strategydevelopment

User develops deeper strategies for top 3-5 most important material issues forthe company, building on NYU Stern CSB guidance; tool provides output summary sheets
Outputs: set of ESG & ROSI KPIs, strategies for top material issues, summary sheets

Source: Arthur D. Little

Source: Arthur D. Little

This phase of the assessment begins with the user

The scatterplot is useful for ensuring that upside

conducting a more in-depth issue prioritization

opportunities are not neglected in prioritization.

(the tool provides the user with further guidance

For example, in the case shown above for a foodon best-practice and scoring criteria). The tooland beverage company, “improving water security’uses this prioritization to generate a second,

appears in the top-right quadrant because alongmore detailed, heat map (not shown here) versus

with the downside risk of poor water stewardship,

the downside/upside/other criteria as shown

there are significant upsides from reducing waterin Figure 4. Along with the heat map, the toolconsumption and wastewater generation. In thisgenerates other outputs, including scatterplots

case, the company realized a 10% water-usage(see Figure 5).

reduction in a few years, aiming for 15% by 2025.

UNLOCKING SUSTAINABILITY VALUE IN PRIVATE EQUITY

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ARTHUR D. LITTLE

VIEWPOINT

Figure 5. Scatterplot showing upside vs. downside rankings
Figure 5. Scatterplot showing upside vs. downside rankings (illustrative)(illustrative)
Issue Prioritization: Upside vs. Downside
20

Improving energy
efficiency & use of18

Mitigating climatechange impacts

renewables

High downside,high upside

Low downside,
low upside

Low downside,high upside

Improving

Reducing use of

16

High downside,
low upsidewater security

harmful chemicals

Downside14
Protecting employee

12

Ensuring safe

health & security

products& services

10

Adopting sustainable

8

packaging solutions

Implementing
sustainable sourcing

6

Protecting customer
Committing to zero4

health & welfare

waste in landfills

2
0
0

3

6

9

12

15

UpsideNote: “High downside” indicates a significant risk to the business if associated strategy is not adopted/enacted

Source:Arthur D.
LittleNote: “Highdownside”
indicates
a significant risk to the business if associated strategy is not adopted/enacted
Source: Arthur D. Little

The tool also provides a variety of scatterplots
to get a better sense of how the material issues
compare and contrast from an upside anddownside perspective.
The next step for the GP user is to develop KPIs
that track ROSI. The tool provides an extensive
database of KPIs that the user can use off the shelf

THE TOOL ENCOUR AGESTHE COLLECTION OF
R E A L S U S TA I N A B I L I T Y
D ATA R AT H E R T H A N T H E
T Y P I C A L C H E C K -T H E - B O X
EXERCISEor as a guide to develop more targeted KPIs fortheir specific business. The database includes, foreach material issue, recommended KPIs and ROSI

The due diligence analysis phase takes a few

descriptions, monetization examples, and typicalhours to complete; the early holding period

good practices. The GP can then begin tracking

analysis requires a longer effort (likely a few days).

these specific, performance-based KPIs throughout

The model is bifurcated to provide value during

the lifetime of their investment. In this way, the tooleach phase, especially given the tight time/resource

encourages the collection of real sustainability data

constraints during the due diligence period.

rather than the typical check-the-box exercise that
often appears in ESG reporting.
Finally, the tool outputs two summary sheets, oneof which highlights the most important findings to
be shared in any investment committee meetings,
as well as an overarching sheet that compiles all
the analysis generated throughout the process forthe top-identified material issues and strategies.

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ARTHUR D. LITTLE

VIEWPOINT

CONCLUSIONCAPTURE FINANCIAL
VA L U E W I T H I M PA C T F U L
S U S TA I N A B I L I T Y S T R AT E G I E S

I N V E S T O R S N O W S E E T H E VA L U E O F
I N T E G R AT I N G A M O R E M E A N I N G F U L
S U S TA I N A B I L I T Y S T R AT E G Y
As PE practitioners increasingly include sustainability priorities
in their investments, there is a significant opportunity to increasefinancial returns while also enhancing environmental and societal
impact. Many private market investors currently focus on ESG andsustainability as a compliance exercise, leaving value-creation
opportunities untapped. However, this trend is shifting as investors
now see the value of integrating a more meaningful sustainability
strategy. Our value creation tool allows GPs to more easily:
1

Identify key material issues and associated risk-mitigating
and value-creating strategies, practices, and value drivers.

2

Provide a high-level assessment of ESG-related risks andopportunities during due diligence that can drive improved
financial performance.

3

Prioritize the most important material issues andrelated strategies to best focus time and efforts on theimplementation of a short list of strategies that drive real
impact.

4

Create KPIs that capture the underlying financial value ofthese strategies, leading to a sustainable growth story at exit.

UNLOCKING SUSTAINABILITY VALUE IN PRIVATE EQUITY

7

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