In recent years, the Environmental, Social, and Governance (ESG) agenda has emerged as a fundamental driver of sustainable company development. However, one of the most significant challenges that businesses face is a lack of high-quality infrastructure for working with ESG data, which makes it difficult to manage, verify, and apply the information required to support their sustainability objectives. Companies worldwide are eager to demonstrate their commitment to sustainable practices by developing ambitious strategies and issuing reports. However, behind the headlines and ambitions is a systemic and frequently underestimated challenge: the sheer complexity of ESG data handling.
The Hidden Risks for Private Equity – Where Can ESG Fall Through the Cracks?
Private equity businesses face unintended consequences when data is missing or erroneous, resulting in poor investing decisions and missing opportunities. It also affects their profits. Here are a few e potential disadvantages of poor data collection throughout the private equity due diligence process.
- Misaligned Valuations
Poor data for analysis in private equity often leads to mispriced investments and distorted valuations. If the private equity due diligence delivers poor data, this results in overpaying for underperforming assets or undervaluing high-potential companies, ultimately affecting returns.
- Operational Inefficiencies
Collecting unreliable data or sticking to just fundamental data during the private equity due diligence process often results in inefficient workflows and resource allocation. Siloed or manual data collection leads to delayed reporting, redundant processes, and a lack of transparency. These inefficiencies reduce productivity and increase costs, making it difficult for PE firms to monitor KPIs and implement practical operational improvements.
- Unrealized Potential for Development
The identification and validation of expansion prospects is a primary responsibility of private equity due diligence. Good data will also guarantee that the PE company scales its portfolio firms and optimizes market positions. However, incomplete data makes it difficult to understand revenue trends, competitive positioning, and client demand.
- Regulatory and Compliance Risks
When evaluating potential regulatory and compliance issues, inaccurate data tracking puts businesses at risk for compliance failures, financial penalties, and reputational damage. Regulatory organizations require detailed financial and operational reporting, and errors can lead to audits, legal challenges, and investor concerns. Without adequate data governance, businesses face more scrutiny and greater difficulties in maintaining regulatory compliance.
- Verification and Assurance
As Limited Partners (LPs) and regulators continue to regard ESG disclosures with the same rigor and scrutiny as financial statements, ESG data assurance is rapidly becoming the new norm. This trend necessitates the increased use of external auditors or third-party validators to ensure the integrity and trustworthiness of reported metrics such as carbon emissions, diversity and inclusion statistics, and governance frameworks. The procedure entails several hidden costs, including as payments for ESG assurance providers, the requirement for improved internal documentation, and detailed process evaluations to support the validation effort. In addition, during assurance, organizations may also discover the data gaps or discrepancies that must be addressed before reporting.
Fundraising is a lagging indicator that responds to industry cash flows. The consequent distribution slowness prompted LPs to reduce new allocations. This tendency is comparable to what we observed during the global financial crisis. Rapid expansion in Assets Under Management (AUM) prior to the crisis was followed by a slowing in exits comparable to what we have seen more recently.
Don’t Just Report It—Leverage It: ESG Data as a Strategic Asset
The problem for private equity companies is clear: gathering ESG data is more than a technical effort; it is a strategic competency. Underestimating its complexity and expense can lead to regulatory issues, delayed value development, and a loss of investor trust. The approach is to incorporate ESG data collecting into the due diligence process, budget for long-term infrastructure and human capital, and view ESG as a dynamic value lever rather than a passive reporting requirement. Companies that invest early and intelligently will be better positioned to fulfill the needs of tomorrow’s financial markets.
NeoImpact’s ESG intelligence platform drives portfolio alignment for investors looking to align their investments sustainably. The platform eliminates confusion arising from dearth of ESG information by focusing on material ESG data, driven by fundamental and alternative sources to build brand reputation, increase portfolio valuation for firms, and optimize market position.
