It Might be Time for Small-Caps to Start Caring About ESG

7 minute read

It Might be Time for Small-Caps to Start Caring About ESG

Nasdaq data shows it could significantly impact your future ability to attract and retain investors.
by Amanda Gerut

So far, sustainability and environmental, social, and governance issues (“ESG”) have resided squarely in the realm of mid- and large-cap companies and their investors. Larger companies and boards that were flat-footed in understanding and operationalizing ESG are now being forced to play catch up and are working to avoid being tagged as ESG laggards by investors and activists.

For small-cap companies, now might be the time to start understanding ESG, speaking to your largest investors about it, and discussing it in board meetings. Companies that can show investors they are ahead of the issue — reducing climate-related risks in supply chains, upholding strong governance norms, and reducing workplace inequality, for instance — will likely fare better when investors start asking questions.

What is ‘ESG?’

ESG is the all-encompassing term to describe a host of issues related to sustainability and environmental, social, and governance topics.

The “E” in ESG refers to “environmental” issues and is often associated with risk oversight and mitigation. Investors typically want to understand how companies are thinking and planning for operational and business-model risks related to the increasing prevalence of climate-change issues, the decline of arable land, water scarcity, and decreasing natural resources.

The “S” stands for “social,” and includes topics related to employee policies, such as pay equity, workplace safety, employee turnover, and processes related to handling misconduct and harassment. Social issues such as stakeholder and community concerns also fall under this category, as well as product liability.

“Governance” is the “G” in ESG. It refers to governance topics such as board oversight, board composition and diversity, the presence of independently led board committees, and the current corporate governance guidelines and processes underpinning the board. Investors want to see boards populated by directors with varying areas of expertise who can demonstrate strong independence and who aren’t on too many boards. Governance also includes issues related to ethics and compliance, such as codes of conduct among suppliers and other sources of potential reputation risk.

Why Should Small-Caps Care?

Right now, most investors in small-cap companies aren’t as focused on ESG as investors in mid- and large-cap companies. This is likely to change.

As you can see in the slide presentation which accompanies this article, a Nasdaq analysis found that the price-to-earnings ratio of companies identified as ESG “leaders” were 11 percent higher than the S&P 500 market average. In comparison, ESG “laggards” were negative .8 percent compared to the market average.

It is clear that ESG is quickly evolving from a “nice to have” to a “must have” in larger public companies. As is often the case in capital markets, what investors are scrutinizing in larger companies often makes its way to smaller companies. ESG is unlikely to be an exception.

Dollars Don’t Lie

In April 2012, there were approximately $30 trillion in ESG-related funds under management. By April 2017, that figure had doubled, and continues to increase. With more than $60 trillion in ESG-related funds, this is not a passing fad.

Forward-thinking larger companies are gauging how to integrate sustainability and ESG in a way that differentiates them from competitors. Boards are reviewing the way returns on capital are impacted by stronger employee engagement and reduced operating costs from more efficient management of energy sources and waste-management programs. Boards also want to know that management teams have thoroughly reviewed the potential environmental risks in the company’s supply chain and that operational disruptions have been minimized.

Moreover, companies are communicating their efforts on ESG to investors and seeing benefits in the form of stronger stakeholder management, improved revenues through increased share prices and the ability to enter new market segments and geographies.

While small public companies needn’t necessarily take the same actions today, high-performing boards should, at a minimum, task management with assessing the ESG focuses of their largest investors.

What Can Small-Cap Companies Do Now?

Here are some steps that small-cap leaders should begin considering:

Make sure you understand if and how your current investors are thinking about ESG.
When you meet with prospective investors, inquire about whether ESG is part of their capital allocation decision-making processes.
For boards, taking the broad issues of sustainability and ESG and breaking it into pieces to identify which particular E, S, and G issues impact their specific company is the first step.
From there, the board and management team should understand the potential risks related to each issue deemed material or significant and manage and monitor them. Adopting a set of metrics the board can review several times a year will allow the company to gauge over time how it is faring.
Companies that can show investors that they’ve assessed their business risks and operations through an ESG lens and can meaningfully communicate their risks and opportunities with metrics, data, and information, will likely be more attractive to investors.
Not all issues related to ESG will be material for all companies, but boards should ensure the management team has carefully considered those that are, and those that aren’t.

Irrespective of company size, investors are focused on ESG, because they believe it will improve long-term shareholder value. As my fellow SCI editorial advisory board member Adam J. Epstein commented in this piece for Nasdaq: “(1) focus on ESG and boardroom thought diversity is not fleeting; and (2) shareholders can likely benefit from both.”

Other constructive Nasdaq resources on this topic are:

https://www.nasdaq.com/news-and-insights/topic/leadership-corporate-governance/esg

https://www.nasdaq.com/news-and-insights/topic/leadership/sustainability

https://www.nasdaq.com/green-voices-newsletter

Sharon Gabrielson, Chair

Board Chair, Sharps Compliance

Sharon Gabrielson is a public and private company Board Director, and C-suite executive with over 30 years of experience across the product and services industry, delivering a successful record in management of highly regulated businesses domestically and internationally. Sharon serves as Chairman of the Board, and on the Compensation Committee for Sharps Compliance (NASDAQ: SMED), a medical waste company. Sharon was most recently Corporate Chair, Global Business Solutions for the Mayo Clinic, the $13B, not-for-profit medical group practice worldwide. Sharon also serves as an Independent Director for Ethos Veterinary Health, a private PE backed, national veterinary health company. Sharon earned an MA in Health Administration and an MA in Management from Saint Mary’s University and a BS in Nursing from Winona State University. She has published numerous publications and presented internationally.

Adam J. Epstein

Founder, Third Creek Advisors

Adam J. Epstein is a former institutional investor, and, now, an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. Prior to Third Creek, he co-founded Enable Capital Management, LLC; Enable’s special situation hedge funds invested in more than 500 small-cap financings. Mr. Epstein is the author of The Perfect Corporate Board (McGraw Hill, 2012). In June 2017, The Perfect Corporate Board was the #1 ranked corporate governance book on Amazon.com. He earned a Juris Doctor from Boston University School of Law, and a Bachelor of Arts, cum laude, from Vassar College.

Ian Cassel

Founder/Chief Investment Officer, Intelligent Fanatics Capital Management

Ian is a full-time microcap investor, founder of MicroCapClub, the MicroCap Leadership Summit, and co-founder of the Intelligent Fanatics Project. Ian founded MicroCapClub in 2011 with the goal of providing a place for investors focused on small-cap stocks to discuss their research in depth. It has since grown into the largest online forum for sub-$300m stocks with over 500 members and subscribers.

Amanda Gerut

Associate Editor, Agenda (Financial Times)

Amanda Gerut is an associate editor with Agenda, a corporate governance publication, published by Financial Times. Amanda writes about board structure, CEO succession planning, executive talent development, director recruitment, board evaluations and director compensation. Currently, Amanda also serves as an advisor on journalism and reporting issues and as a senior editor for environmental, social and governance issues at CleanTechIQ, a publication focused on renewable energy and venture capital financing.

David A. Scher

Founder

During a 15-year tenure investing his family’s capital in small-cap companies, David has met with hundreds of small-cap officers and directors. He has occupied a front row seat to the unique challenges that routinely vex small public companies, and seen how otherwise smart, well-intentioned CEOs and boards make similar, repetitive, value-destructive decisions. A natural problem solver, he realized through years-long observation that the problem was an educative one. More specifically, the capital markets, corporate finance, and corporate governance issues that small-cap CEOs and boards face lack intuitive answers. In place of those intuitive answers is often the highly variable advice from service providers who are simply guessing how investors think. Consequently, in 2017, David founded Small-Cap Institute, and began to work on assembling that missing, comprehensive, educative resource. Previously, David joined LD Micro in 2014 to help manage the construction of the first true micro-cap index – the LD Micro Index – and oversee the rebuild of the ldmicro.com website. At LD Micro, now owned by SRAX, Inc., David was responsible for planning and executing LD Micro’s industry leading conferences each year, wherein over 5,000 one-on-one meetings between investors and micro-cap companies are facilitated. As a result of his work with LD Micro/SRAX, David occupies a unique vantage point from which to understand at a granular level which issues are most troubling to small-cap CEOs and boards.

Brian Balbirnie

CEO, Issuer Direct (NYSE: ISDR)

Brian Balbirnie serves as the Chief Executive Officer and strategist of Issuer Direct. Brian established Issuer Direct in 2006 with a vision of creating a technology driven back-office compliance platform that would reduce costs as well as increase the efficiencies of the most complex tasks. Brian is responsible for the strategic leadership of the company and oversees day-to-day operations. Under Brian’s direction, the Company has grown to serve over 2,000 companies since 2006. Brian is an entrepreneur with more than 20 years of experience in emerging industries. Prior to Issuer Direct, Brian was the founder and managing partner of Catapult Company, a compliance and consulting practice focused on the Sarbanes Oxley Act. Prior to Catapult, Brian also advised several companies on their public market strategies, Merger & Acquisitions as well as their financial reporting requirements.

Dr. Rollie Carlson

CEO, Immunexpress, Inc.

Rollie Carlson is CEO of Immunexpress, Inc. He has over 25 years of global commercial, business development experience in the biotechnology space including fund raising in both public and private capital markets. Prior to Immunexpress, he was President and CEO of WaferGen Biosystems (NASDAQ:WGBS) a life science genomic company; President and CEO of Asuragen Inc., a molecular diagnostic company; and, he held several leadership positions at Abbott Laboratories NYSE:ABT). He has a Ph.D., in Biology/Botany from Southern Illinois Iniversity.