The original blog post in Japanese was published on August 3, 2022. 

In our previous post, we discussed the first two of the four essential ESG factors for any technology startup – DEI and data security and privacy. In this post, we explore board composition and climate action. 

Board composition

During the early years of a startup, its board (if the company has one) understandably tends to be composed of a small group of insiders. An extensive study examining startup boards finds that the average size of the board at a startup’s first financing is 3.6 members, with principally all board seats being held by only the founders and senior executives. Further findings from the study highlight that over a business’s life as a startup, the average board size is 4.4, with approximately 2 seats being held by investors (usually VC funds), 1.7 executives, and only 0.8 independent directors.

These findings highlight one clear challenge of startup boards: namely, that they often are not sufficiently independent. However, from a practical perspective, it takes time to build a board that has the right mix of independence, diversity, and experience. There are also a range of particular challenges facing technology startups resulting from it typically taking longer for them to reach IPO status, such as various conflicts of interest on boards and multi-class share structures (these are all explored in depth in this very helpful article).

Responding to both these dynamics and the many governance failures among both private and public market companies, improving corporate governance has been an increasing area of focus among regulators and exchanges around the world. Recent revisions to Japan’s Corporate Governance Code, London Stock Exchange’s min. 50% non-executive director rule, and NYSE and Nasdaq’s majority independent board composition requirements are just a few that pre-IPO companies should be aware of and begin to prepare for.

In addition, diversity on boards has become an increasingly pertinent subject for companies of all sizes. With growing evidence that diversity boosts innovation and financial performance, governments and exchanges have moved to enact laws and rules aimed at improving diversity on boards. 

For example, EU member states have given initial approval to legislation requiring that, by 2027, listed companies or those with at least 250 employees must ensure that 40% of all non-executive director roles are filled by women (equalling 33% of all board jobs). Member states would only be exempt from the rule if they already had board diversity rules in place.

Also, Nasdaq’s widely reported 5605(f) Rule requires companies to have two diverse board members or to provide an explanation as to why they haven’t met this requirement. One of the two members must self-identify as female and the other as a member of a racial or ethnic minority and/or the LGBTQ+ community.

Startups are now compelled to consider much earlier in their development how they might build a highly experienced, diverse, and sufficiently independent board. It is important to keep in mind that, ultimately, companies should aim to build a board that is:

• Competent: has the right skills and experience to help the company grow
• Independent: able to provide ideas and direction that are less clouded or influenced by relationships with the management team
• Diverse: with a broader range of different ideas and experiences

Startups are generally owned by the founders, so it is extremely important to show the capital markets that the company has a solid governance system.

Naoto Hoshi, CEO and Director, Unifa Inc.
Read the full interview

Climate action

In the past, the technology sector largely escaped scrutiny with respect to its impact on climate change, the assumption being that in comparison with industries such as oil & gas, transportation, or mining, its impact was fairly low. Under current circumstances, this may in fact still be correct, as tech currently accounts for 2-3% of global emissions. However, this should not relieve the sector of its responsibility to address the climate challenge.

Tech is a fast-growing sector, and its climate impact is only increasing. It is estimated to hit 15% of global emissions by 2040 if current trends continue. In addition, the countries whose technology sectors are growing fastest do not yet have the renewable energy capacity to keep up with the energy needed to power tech’s rise, thereby continuing their reliance on fossil fuel energy.

As technology companies become even more integrated into our lives, their influence on the attitudes, behaviors, and actions of their billions of users around the world will continue to grow. In addition, as countries and industries attempt to de-carbonize, they look to the technology sector to provide the solutions to enable this shift. Thus, tech will be looked at as not just a solution provider in this area but also an important steward of changes in attitude and behavior.

Finally, investors see climate change and its impacts as a risk, and are therefore pushing for more emissions transparency and climate action from companies of all sizes. Responding to investor engagement and pressures, countries and their stock exchanges (e.g., UK‘s LSE, HK’s  HKEX, NZ’s FSAA, US’s NASDAQ, Singapore’s SGX, EU reporting requirements affecting all EU exchanges) are stepping up their climate and sustainability reporting requirements. In Japan, companies are expected to be required to open their climate action along with wage gap by gender and percentage of female managers as part of a description on important matters stated in its Annual Securities Report from 2023. 

Investors, startup employees, regulators, as well as top founders advocate for a greater sense of responsibility within the technology sector in respect to minimizing its climate impact. While this urgency regarding climate risk may not be immediately apparent to startup companies, we believe it’s critical that pre-IPO businesses measure, manage, and reduce their carbon footprint.

We’ve covered the four essential ESG factors over two blog posts, and in the coming posts, we will discuss practical steps in the ESG journey. 

We thank Trista Bridges for her contributions to this post.