Trickle-Down ESG: The Impact of ESG Initiatives on Small-and-Medium-Sized Businesses

Trickle-Down ESG:

(Credit: Canva Pro)

by | Mar 8, 2023

Trickle-Down ESG:

(Credit: Canva Pro)

As Fortune 500 companies continue to expand ESG initiatives, how will this impact smaller businesses, particularly those that provide services or products to large companies?  Will there be clear winners and losers, or will the outcome be more nuanced, like in the history of trickle-down economics?

Trickle-down economics refers to the belief that if high-income earners increase wealth, then everyone in the economy will benefit as this increased abundance filters through to all sections of society.  To this day, there is significant debate over whether trickle-down economics actually provides a net benefit or whether it disproportionately advantages high-income earners.

As ESG (Environmental, Social, and Governance) initiatives continue to be adopted by larger businesses, the concept of trickle-down economics presents an interesting analogy.  Customers, investors, and stakeholders expect public companies to take a stand on issues related to sustainability, social justice, and corporate governance.  Regulators in the United States, such as the Securities and Exchange Commission, are also moving towards the adoption of ESG-related requirements.  However, in order to implement these initiatives, larger businesses will need to work with their vendors, many of which may be small- and medium-sized businesses (SMBs).  This is likely to lead to increased pressure and costs for SMBs, but also will create more resources and opportunities for SMBs to benefit from ESG initiatives.  What does this mean for SMBs?  How can SMBs navigate these requirements to their benefit?

As an initial matter, ESG requirements will be passed down from large companies to SMBs through written agreements between these entities.  As a result, SMBs need to pay close attention to changing contract terms relating to ESG. A typical contractual provision passing ESG requirements to an SMB, often known as a “supplier climate clause” will have a few components:

  • Reporting – This aspect of a supplier climate clause requires suppliers to measure and report their environmental footprint or other ESG metrics. Sometimes, this is done through an established reporting framework, and other times is done through the reporting of specific information, such as energy and materials usage.
  • Targets – This aspect of a supplier climate clause requires suppliers to meet certain targets for the reduction of environmental footprint or other ESG metrics. For instance, a supplier may commit contractually to reduce electric usage by a specified percentage over a specific period of time or reduce greenhouse gas emissions in a similar manner.
  • Cooperation – This aspect of a supplier climate clause required suppliers to cooperate with the customer company to achieve a reduction of environmental footprint or other ESG metrics.
  • Compliance – This aspect of a supplier climate clause identifies relevant statutory and regulatory compliance requirements relating to ESG and specifies whether and to what extent the supplier or the customer company is responsible for compliance. These provisions can also dictate whether the other provisions of the contract need to change based on changes in compliance obligations.

Supplier climate clauses raise both legal and operational issues.  From an operational perspective, SMBs that have not already begun to address ESG may not be familiar with measuring and reporting their environmental footprint and may not be well equipped to report the footprint for the specific services or products provided to a given large company.  Setting up reporting protocols can be costly and require training and record keeping.  In many industries with low-profit margins, SMBs may be reluctant to incur these additional costs.  Further, as noted above, even once SMBs are able to track the footprint based on the product or service that is provided to a large company, the SMBs may be required to commit to reducing the footprint associated with this service or product.  While there are many ways to accomplish these emissions, it again creates cost issues as emissions reductions can be capital-intensive.  SMBs may need to increase pricing to meet these emissions reduction targets but may have difficulty spreading the costs across all customers if only one or a few are pressuring the SMB to meet the targets.

From a legal perspective, as noted above, SMBs should carefully review any ESG-related provisions and keep the following questions in mind:

  • Who will be responsible for tracking legal requirements relating to the customer company’s products or services that will impact the supplier? The products or services offered by the customer company may be sold across a wide geographic area, and even internationally, and there may be different legal requirements in different areas where the customer company operates.  ESG-related contract provisions should clearly specify the relative responsibilities of SMBs and the customer company.  To the extent that the SMB assumes responsibility for compliance, it may be beneficial to limit that responsibility to certain identified legal requirements unless the SMB has the resources to track and adapt to changing requirements.
  • Will the customer company provide resources to help the SMB comply with ESG-related contract provisions? Larger companies deal with many different SMBs and can act as a clearinghouse and resource for ESG-related information. While customer companies may be reluctant to increase costs despite the addition of ESG provisions to contracts, it is more likely that these companies will agree to provide resources or support to SMBs in complying with these new provisions.  SMBs should request revisions to ESG-related contract provisions to specify exactly what level of support will be provided.
  • How specific is the ESG-related provision? At times, ESG-related provisions are included in B2B agreements that are very general and imprecise.  While this can be better than precise provisions that impose substantial obligations on SMBs, it is important to ensure that general provisions do not impose unreasonable obligations on the SMB.  At the very least, when faced with a general provision an SMB should have a discussion with the customer company to understand expectations and consider incorporating those expectations more precisely into the ESG provisions.
  • Is it possible to standardize your ESG-related provisions across different contracts? SMBs should work to standardize requirements across vendor agreements for different customer companies.  While this may be difficult, large companies are beginning to understand the impact of ESG initiatives on SMBs and may be more receptive to this type of request, especially if customer companies are within the same industry.

In terms of opportunities, while SMBs may have more limited resources for ESG initiatives, there are still many things that SMBs can do to take advantage of the benefits provided by ESG initiatives.  For one, regardless of resources, SMBs can develop an ESG policy.  An ESG policy is basically a mission statement that describes the SMBs commitment to ESG principles and provides a foundation for incorporating ESG into decisions.  Whether or not required by customers, SMBs can also begin tracking key metrics easily and efficiently, such as energy and material usage.  The relevant metrics will depend on the specific industry and context, but there are many resources available for SMBs that want to proceed in this manner.  For instance, SMBs should be sure to work with industry groups, where available, to share resources and best practices.  SMBs should also keep an eye out for grants and incentives tailored to SMBs that are adopting ESG initiatives.  At the end of the day, SMBs have the opportunity to start where they are because ESG s a journey and not a destination.  Incremental steps can add up to significant ESG initiatives, and documenting these steps can be very beneficial, allowing SMBs to differentiate themselves from competitors, reduce costs, and access new markets and funding sources by embracing ESG.  By taking a proactive approach to ESG initiatives, SMBs can position themselves for long-term success in an increasingly competitive and values-driven business landscape.

So, everyone must decide for themselves, is ESG more of an opportunity or a challenge for SMBs, and will the adoption of ESG initiatives by larger companies benefit or burden SMBs?  Only time will tell but given the benefits of ESG initiatives for larger companies, SMBs that can figure out how to navigate in this area is likely to be more successful.

Guest Author

Matthew Karmel Attorney

(Credit: Matthew Karmel)

Matthew Karmel is chair of the Environmental and Sustainability Law Group at Offit Kurman and founder of the Planetary Lawyer Project, a resource for helping lawyers do more climate-focused work. His practice combines traditional environmental compliance and litigation with cutting-edge sustainability counseling.

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