Reshaping deals: ESG across private equity

September 2025  |  FEATURE | PRIVATE EQUITY

Financier Worldwide Magazine

September 2025 Issue

Of all the buzzwords influencing the corporate environment in recent years, environmental, social and governance (ESG) is among the most significant. This acronym encompasses a broad range of factors that must now be considered when evaluating the potential impact of an investment.

Whereas profit was once the primary measure of a company’s performance, ESG represents a new paradigm – one that supports a more holistic approach to investment decisions. This approach considers not only financial returns but also the broader societal and environmental impacts of investments.

“ESG is bespoke and its value and role will vary company to company,” says Harriet Assem, head of sustainability at the British Private Equity and Venture Capital Association (BVCA). “However, there is a commonly accepted consensus forming that effective ESG strategies ‘just make good business sense’.

“The associated advantages from effective ESG integration are multipronged and extend beyond just risk management and value creation,” she continues. “These include improved access to capital, talent attraction and retention, improved resilience, and trust building with stakeholders.”

Private equity and ESG

One investment arena increasingly embracing ESG is private equity (PE). Across this asset class, the integration of ESG factors has become a defining feature, reshaping how deals are sourced, due diligence is conducted and value is created.

“ESG factors are being considered in greater detail during due diligence processes and will likely affect any 100-day plans set by new management,” concurs Ms Assem. “There is evidence that companies with strong ESG integration and data collection use the information to effectively understand operations, supply chains and decarbonisation action plans, and to take advantage of potential ESG opportunities.”

Supporting this trend is Invest Europe’s ESG KPI Report: Managing What You Measure, which found that 77 percent of private capital firms had ESG investment and portfolio management processes in place in 2021, with 90 percent of buyout firms reporting such integration.

These findings reflect the sector’s growing appetite for ESG impact, driven by investor demand, regulatory expectations and a broader understanding that responsible investing supports long-term value creation.

Acuity Knowledge Partners’ Global Private Markets Outlook 2025 further confirms that sustainable investments now account for a larger share of total investments, with a particular focus on climate action, healthcare, water and the circular economy.

The report also highlights the increasing adoption of globally recognised ESG frameworks, such as the United Nations Global Compact and the Global Real Estate Sustainability Benchmark, due to their clearly defined metrics and practical applicability.

“ESG is a competitive differentiator for PE funds as it impacts several areas, including mitigation of long-term risks and enhancing operational efficiency,” says Ambarish Srivastava, associate director, private markets at Acuity Knowledge Partners. “ESG credentials are also known to improve exit valuations of assets in the PE market, as buyers now prioritise ESG-compliant assets.

“In addition to financial returns, limited partners (LPs) and general partners are now evaluating assets that show a measurable impact on ESG parameters,” he continues. “Various studies suggest a tenfold increase in impact strategies, while private markets assets under management have been at an all-time high.”

While PE investors are well-positioned to seize opportunities in ESG-focused sectors, they must also navigate the challenge of balancing ESG considerations with the imperative to deliver high returns.

Integration challenges

Given ESG’s growing prominence in dealmaking, evaluating a target’s ESG goals, climate agenda, and approaches to diversity, equity and inclusion can pose significant challenges for PE firms. These are further complicated by the global net-zero agenda.

According to Invest Europe, 31 percent of portfolio companies had implemented environmental management systems in 2021, with 56 percent of those being externally certified. Additionally, 17 percent of PE- and VC-backed companies had committed to net zero. These metrics underscore how ESG is influencing operational priorities and investment decisions, particularly among buyout-stage companies, which tend to have greater resources to support such initiatives.

“Considering ESG factors at a pre-deal stage, namely deal sourcing and due diligence, helps investors screen out investments from generally controversial sectors, such as weaponry, alcohol and fossil fuels, thereby derisking the portfolio,” says Mr Srivastava. “However, despite the pros, the cons remain considerable.

“These include data availability at issuer level, an incoherent regulatory environment, a fragmented approach toward integration and the limited level of influence LPs have over their investments,” he continues. “More recently, it has also become challenging to address limited ESG benchmarking for private assets and balance short-term performance pressures with long-term ESG goals.

Another complicating factor, Mr Srivastava argues, is a skills gap across investment organisations. Many firms lack the expertise to identify ESG risks that are material to specific sectors, as well as the experience to establish reference points for ESG best practices.

Balancing ESG and value

For leaders in the PE industry, the challenge of balancing ESG considerations with the delivery of high returns is both nuanced and complex. It requires careful navigation of opportunities and tensions alike.

“PE leaders must embed ESG into their core investment processes by defining material ESG criteria per sector, setting key performance indicators and aligning incentive structures,” contends Mr Srivastava. “Transparent reporting and collaboration with portfolio companies on significant issues are non-negotiable. Leaders should take a customised approach to ESG implementation to enhance their firm’s value, instead of opting for a ‘one size fits all’ approach.

“While embedding ESG considerations into investments can assist PE investors in identifying sectors which can bring considerable risks to their portfolio, it may also help them tackle energy efficiency, technology and climate change,” he continues. “Therefore, a suitable ESG approach can lead to identifying underserved markets, reducing risk premiums and capturing innovation linked to sustainability.”

Nevertheless, investors must be prepared to address tensions that may arise when ESG goals conflict with short-term return expectations or when metrics are difficult to quantify.

In particular, the challenge of quantifying social impact remains a persistent issue. While environmental metrics such as carbon emissions are increasingly standardised, social indicators – such as employee wellbeing, community engagement and equitable pay – are more subjective and harder to benchmark. This lack of uniformity can hinder comparability across investments and complicate reporting obligations. As a result, many firms are investing in internal ESG expertise and third-party advisory services to strengthen their frameworks and improve data quality.

According to Invest Europe’s benchmark report The Performance of European Private Equity 2023, the sharp rise in ESG integration – 90 percent of firms having ESG investment and portfolio management processes – demonstrates that the alignment of sustainability and financial goals is closer than ever.

The report also states that, whether alignment is assessed in terms of net internal rate of return or total value to paid-in, one conclusion is clear: European PE, venture capital (VC) and infrastructure consistently outperform public markets, while also matching the performance of their North American counterparts.

Ms Assem similarly acknowledges that embedding ESG considerations contributes to both value protection and creation. “However, the ESG landscape is very noisy and can be hard to navigate,” she says. “So, firms need to build and implement an ESG strategy that covers the key elements to consider, and signpost tools and best practice guidance.”

“To prevent it becoming a tick-box exercise, a good understanding of ESG strategy and purpose is required to ensure each individual approach remains meaningful and impactful to PE investors and portfolio companies,” adds Ms Assem.

Private equity versus retail

As a mechanism for value creation, private markets are uniquely positioned to drive ESG initiatives. Unlike public markets, such as those accessed by retail investors, where influencing costs and strategy can be challenging, PE investors have greater control and the ability to implement changes that enhance value.

“The approach taken by PE companies is more strategic, data-driven and long-term compared to retail investors, who often rely on ESG ratings or thematic funds,” affirms Mr Srivastava. “PE firms can shape high impact ESG outcomes via governance influence and operational control. Additionally, while retail investors focus on exclusion or positive screening, PE investors emphasise transformation and engagement for long-term value.”

As evidenced by Invest Europe, PE firms are able to directly engage with portfolio companies and shape their ESG strategies – from setting net-zero targets to implementing governance reforms and improving workforce diversity. This hands-on involvement, combined with longer investment horizons, enables PE and VC firms to adopt a strategic, value-driven approach to ESG.

“PE firms strategically integrate ESG into their investment processes, not just for risk mitigation, but as a value creation and protection lever,” adds Ms Assem. “This is because companies with strong ESG credentials often command higher exit multiples, especially from institutional buyers or initial public offerings, where ESG performance is under greater scrutiny.”

Change agent

With PE-owned companies typically operating on longer time horizons than publicly traded firms, the institutionalisation of ESG within PE is maturing. This evolving landscape offers strategic benefits conducive to value-generating opportunities.

“As highlighted in our latest ESG survey, private capital is already driving sustainable change throughout the economy,” states Ms Assem. “The active ownership model uniquely positions it to embed sustainability across diverse sectors and within parts of the economy listed companies cannot reach.”

By way of example, Ms Assem cites restaurant chain Hawksmoor’s partnership with Graphite Capital. This initiative introduced an efficient waste and recycling programme, with active engagement across the supply chain to drive ESG and value improvements. Leveraging carbon accounting and sustainability practices, Hawksmoor’s UK beef farms are committed to reaching net zero by 2040.

Across Europe, companies are moving beyond regulatory minimums and embracing ESG as a performance differentiator, notes Invest Europe. Among managers subject to the Sustainable Finance Disclosure Regulation (SFDR), 84 percent of vintage funds in 2023 were classified as article 8 or 9, indicating that ESG is central to their investment strategies. Even firms not subject to SFDR are voluntarily aligning with the framework, reflecting growing industry-wide transparency.

Additionally, a 64 percent increase in companies reporting diversity data in 2023 signals a rise in transparency and accountability. With PE, VC and infrastructure investments spanning 8353 portfolio companies across Europe and employing 19.9 million people, Invest Europe asserts that the industry has unmatched reach to drive positive change.

Furthermore, the growing emphasis on ESG is influencing talent acquisition and retention within PE firms themselves. Younger professionals entering the industry increasingly prioritise purpose-driven work and seek employers with strong sustainability credentials. Firms that demonstrate authentic ESG commitments are better positioned to attract top talent, foster employee engagement and build resilient organisational cultures. This internal alignment further reinforces the long-term value proposition of ESG integration.

“PE is well positioned to act as the catalyst for sustainable investments to become mainstream,” suggests Mr Srivastava. “Among the different asset classes, PE is leading in sustainable investments. The sector’s ability to influence management, allocate capital strategically and scale innovation allows it to be strongly positioned as a powerful change agent.”

As ESG continues to evolve, PE is uniquely placed to lead the charge. By aligning purpose with performance, the industry can unlock long-term value while driving meaningful, measurable change.

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Fraser Tennant