Private business owners and entrepreneurs know that relevant data is vital to their businesses, in particular its financial performance.

Identifying the most relevant and hence useful data rests on the concept of materiality. This matters also for customers, stakeholders and investors.

In this piece, the first of a three-part series, we’ll explore materiality and why it matters today, particularly as its definition increasingly extends to cover sustainability metrics around environmental, social, and corporate governance (ESG) performance.

Executives & Entrepreneurs

Authors: Matthew Carter, Strategist, UBS AG London Branch; Amantia Muhedini, Sustainable & Impact Investing Strategist, CIO Americas, UBS Financial Services Inc. (UBS FS)

 

This report has been prepared by UBS AG London Branch and UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures at the end of the document.

materiality data

The world is awash with data.

According to IDC, EMC, and Bloomberg Intelligence, the annual size of the data universe was about 64 zettabytes in 2020, more than 50 times what it was in 2010. We in the UBS Chief Investment Office expect the global data universe to expand by a factor of more than 10 from 2020 to 2030, reaching 660 zettabytes—equivalent to 610 128 GB iPhones per person.

Private business owners and entrepreneurs know that relevant data is vital to their businesses, in particular its financial performance. Identifying the most relevant and hence useful data rests on the concept of materiality. This matters also for customers, stakeholders and investors.

In this piece, the first of a three-part series, we’ll explore materiality and why it matters today, particularly as its definition increasingly extends to cover sustainability metrics around environmental, social, and corporate governance (ESG) performance.

In part 2 of this series, we’ll explore sustainability materiality by exploring how ESG factors affect an entrepreneur’s.

business. We’ll look at costs, risks, and the mitigation strategies founders can adopt to maintain profitability and sustainability.

And in part 3 of this series, we’ll explore how sustainability materiality is increasingly focused on so-called “double materiality,” why entrepreneurs may have to pay closer attention to their firm’s impact on the wider world, and suggest how business owners can make an impact in the most financially efficient way.

So what is materiality?

Materiality is the term given to describe company data or facts that regulators believe the average prudent investor would reasonably want to know before buying a publicly traded stock.

It is not a new concept to describe information as material.

The term “material” first appeared in the US Securities Act of 1933. Its scope was tested in a 1976 case, when US Supreme Court Justice Marshall clarified that an item is material if there were “a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.”

It is a new concept for materiality to extend beyond the largest publicly listed companies to be a matter of concern for consumers and other stakeholders, and potentially to encompass more than traditional financial accounting metrics.

Why does materiality matter today?

Materiality lies at the heart of the debate around the US Securities and Exchange Commission’s proposal to require all public companies to include data on certain climate- related risks (for example the company’s greenhouse gas emissions) in registration statements and periodic reports.

It is not unreasonable for business owners to think that where publicly listed companies go, privately held companies could follow.

And while the regulatory environment, especially in the US, remains open to consultation and finalization, entrepreneurs operating globally are likely aware of far- reaching sustainability rules and regulatory developments elsewhere in the world. Reporting requirements from the UK’s Taskforce for Climate-Related Financial Disclosures are just one example of this.

We believe that there are three facets of the term materiality that business owners should consider:

1. Materiality increasingly covers more than just what investors care about

In our research From public to private: three incentives to get ahead of sustainability regulation, we suggested that private companies’ sustainability data is increasingly becoming material to a business’s supply chain, funders, and end customers.

Entrepreneurs seeking to work with large multinational companies may find that reporting on environmental criteria, such as carbon emissions across the value chain, or social metrics, such as gender pay gap statistics, is mandatory to securing or retaining a relationship.

Business owners may find that certain funding sources and insurers tie the cost of capital or coverage to exposure to climate-related risks. And in Europe, many large asset holders (some of whom would consider buying privately held companies as part of their investment strategies) will only consider target companies that support and report on sustainability goals like climate change mitigation, the prevention and control of pollution, or the protection and restoration of biodiversity.

And end-customers may also believe certain sustainability data is material, even if business owners judge it has no material impact on corporate financial performance. Failure to meet the public’s sustainability requirements may cost. An April 2021 survey of 1,000 US consumers found that near 40% would boycott a company for not being environmentally conscious, while near 20% had already spent their money elsewhere.

2. Materiality on sustainability is becoming a two-way street

At first, sustainability materiality—identifying the environmental, social, and governance issues that mattered —could be described as “outside-in.”

Put differently, public and private business owners (and their customers and stakeholders) considered ESG factors as outside developments that posed risks and cost in the business. In our research paper Three steps to becoming more sustainable…and profitable, we suggested a number of “outside-in” sustainability factors that have become growing requirements for companies to identify, measure, and monitor.

But this definition of materiality, which we’ll explore more in part 2 of this series, is not the only way in which corporate sustainability can matter.

Many stakeholders, such as consumers, sustainable and impact investors, and other companies along the value chain, also now look at sustainability materiality from an “inside-out” perspective.

In this approach, business owners and executives ask how their business models (inputs, operating processes, and outputs for example) deliver positive or negative environmental or societal consequences on the outside world at large.

This concept of double materiality, on which we’ll expand in part 3 of this series, is not yet universally accepted. Some business owners and executives might argue that delivering financial returns to stakeholders takes precedence over delivering impact. Others might say the means of measuring impact are too burdensome, expensive, or lack the consistency of financial reporting.

Nevertheless, ongoing regulatory developments, especially in Europe, look likely to enshrine double materiality within a consistent, global framework for sustainability reporting. This makes it important for private business owners to understand double materiality, even if its application is neither legally mandated nor aligned with entrepreneurs’ personal sustainability views.

3. Materiality matters more for entrepreneurs’ exit plans

Business owners whose financial plans include an eventual sale or exit may find that sustainability transparency and materiality (in both directions) matter increasingly for attracting a buyer.

In our research paper Three ways sustainability transparency can affect your business exit, we suggested that private firms that lead their peers on ESG factors, both in terms of managing financial risks and costs as well as seizing opportunities to deliver positive impact, may experience better exit pricing and conditions than lagging firms.

We also suggested that entrepreneurs who have already identified scope for ESG improvement and may even be open to sustainability engagement could use this apparent weakness as a sign of strength to attract alternative buyers.

For example, entrepreneurs who previously thought their primary sale route would be acquisition by a strategic competitor may find that scope for sustainability improvement appeals to a financial acquirer like a private equity house or family office.

Sustainability is a growing feature of these buyers’ requirements. Fundraising by general partners with formal, firm-wide ESG policies rose to USD 630bn and over half the annual total according to McKinsey’s Private Markets Annual Review 2021. At the same time, 41% of family offices are more actively allocating to companies and sectors that are focused on directly impacting real world issues, according to the UBS Global Family Office Report 2022.

Conclusion

Materiality was historically the term given to describe company data or facts that regulators believe the average prudent investor would reasonably want to know before buying a publicly-traded stock. Today materiality matters to a wider circle of actors including customers, regulators, and stakeholders. 

Materiality does just apply to listed companies. Business owners would do well to understand the concept to ensure they use scarce resources to measure what matters.

Debate is fierce around how sustainability data fits into the materiality framework.

Regardless of the regulatory outcome, we believe founders should consider three aspects of materiality, and prepare or pivot their business accordingly:

1. Materiality increasingly covers more than just what investors care about

2. Materiality on sustainability is becoming a two-way street

3. Materiality matters more for entrepreneurs’ exit plans

Supporting documents

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