2.1 Who Are Venture Capital Investors and Why Do They Matter in the Context of Human Rights Implementation?

vc investors constitute a subset of private equity investors who are specialized in early-stage and high-growth companies,⁶ often referred to as startups. vc investors focus on providing the knowledge and financial resources to support startups from their inception to their exit, which typically is an acquisition by a larger corporation, an initial public offering, or bankruptcy. To do so, vc investors raise funds from private individuals, pension funds, corporations, financial institutions or governments, commonly referred to as limited partners (lp).⁷ They then scout for startups with high potential of returns and invest significant amounts of cash in exchange for equity. Once the investment is made, they help the startups in their portfolio reach their growth target by sitting on their board, introducing them to potential customers, sharing their knowledge and networks, and providing further access to financing through successive funding rounds. When the company exits, vc investors intend to make a profit on their investment, which will be partially redistributed to their lps. As approximately 70% of the investments fail to provide a positive return,⁸ vc investors rely on a small portion of their portfolio of investments to generate sufficient returns to cover for losses and generate a profit. This has been sometimes referred to as the ‘baseball strategy’, where home runs help win the game.⁹

The global venture capital market is relatively small compared to the public market, as it represents $2.5 trillion of assets under management (2022).¹⁰ However, the impact of the vc firms on our world must not be underestimated, as their investments will decide which technologies will strive and which will fail.¹¹ For example, the rise of artificial intelligence startups (ai) in late 2022 is a direct result of the $19 billion the vcs poured in ai in 2018 alone.¹²

Furthermore, vcs often have a stronger hold than other investors on the governance of the company they invest in. Building and growing a startup requires a lot of capital and expertise that they can specifically provide. vc investors and the other shareholders of the company negotiate shareholders’ agreements in which they agree on a common set of rules on how the company shall be managed and how they should act as shareholders. In addition, shareholders’ agreements provide investors with specific privileges and rights, both financially (liquidation preferences) and socially (board representation, veto rights, etc.).

As vc investors have a strong influence on the technologies that we, as a society, use today and will use tomorrow, they have an opportunity to play a crucial role in the adoption, or lack thereof, of human rights due diligence (“hrdd”). Most of them are uniquely positioned to allocate their funding to startups that do not negatively impact human rights or engage in human rights abuses. This is especially important for startups developing frontier technologies,¹³ such as ai,¹⁴ cloud computing, autonomous driving, drone surveillance, or bioengineering, where the risk of human rights abuse is even greater.

2.2 What Are the Challenges Faced by Venture Capital Investors When Trying to Integrate Human Rights Considerations in Their Processes?

Historically, venture capitalists have fallen short of demonstrating an impressive record on esg matters, positive impact and sustainability. Critics have long highlighted the lack of diversity and inclusiveness among the leading players of the industry.¹⁵ Probably as a result, many companies backed by venture capital have also disregarded human rights in general, ignoring in particular basic rules in terms of privacy and labor rights.¹⁶ Coupled with the largely unchallenged ‘move fast and break things’ motto, it is of no surprise that venture capitalists have not led the way so far towards promoting proper esg and, in particular, hr aligned responsible investments.

Indeed, a 2021 report from Amnesty International found that only one out of the 53 vc investors they interviewed had human rights due diligence processes in place.¹⁷ Furthermore, according to a 2022 survey conducted by the Principles for Responsible Investment (“pri”), 83% of the investors surveyed found it difficult to incorporate esg factors in their investment process due to the many challenges they are facing when doing so.¹⁸

Among these challenges, vc investors struggle to remediate the integration of human rights considerations with startups’ grow-at-all-costs culture. Implementing credible hrdd processes usually requires hiring specific personnel, which will incur costs for the startups that often rely on very limited resources.¹⁹ As nearly three quarters of startups eventually run out of money,²⁰ they often prioritize developing their product and focusing on their growth over designing potentially costly hrdd processes.

vc investors also cite as an obstacle the lack of transparency and the culture of secrecy that is still predominant in the startup world.²¹ As startups are private companies, very few disclosure requirements are legally mandated. Investors must rely on the information that is provided by the startups’ management. If they fail to implement appropriate information flows, they are at risk of failing to identify potential adverse human rights impacts.

Finally, 86% of investors surveyed by pri stated that they fail to find appropriate resources to identify relevant sets of esg metrics.²² The lack of unified metrics and industry standards tailored for the needs of vc investors is another barrier to appropriate hrdd processes.

All such arguments are valid but certainly not a reason to abstain. Furthermore, other arguments are even more debatable. For instance, vc investors often claim they lack influence over company management. As they compete to secure the best investments, they are inclined to adopt a founder-friendly approach to be accepted as investors. This can lead to inadequate checks and balances within the company and make it more challenging to enforce the adoption of essential hrdd processes. Even when vc representatives are involved in company management, such as serving on the board of directors, they may struggle to take an active role across all their startups. A single investor might manage up to 30 startups in the portfolio,²³ resulting in insufficient time and resources to attend each board meeting.

Or so the story goes. In truth, opportunities for vcs to make a positive impact are real, but they greatly vary depending, in particular, on the timing of the investment and the maturity of the target. In early-stage investments, founders are crucial to the early traction of the company, and vcs, which have to buy their way in for the best candidates, might have difficulty addressing a proper and comprehensive discourse with regard to hr, let alone esg. In syndicates, only the lead investor will negotiate, and mission alignment discussions are often secondary to financial valuation. As minority shareholders with only a limited set of protective provisions designed to protect the investment rather than promote a sustainability agenda, impact driven by vc investors may be initially limited.

However, the argument progressively turns into an excuse in growth investments, which materialize at a later stage. Startups are then less dependent on their historical founders, proper business plans are drafted and implemented, and management seniority is usually strongly reinforced. Even if the vc investors may still represent a minority on the cap table, their stake is strategic and their votes are required. At the board level, founders and investors work hand in hand with independent directors, each presumably acting in the best interests of the company rather than focusing on individual stakes. Board committees also sometimes further enhanced governance and provide additional checks and balances. Growth may also be fueled by debt, with non-equity investors often imposing more discipline and stricter processes than early-stage vcs. Operations may thus more easily integrate esg measurement and start mapping the main stakeholders in its ecosystem, from employees to suppliers, resellers and customers.

2.3 What Regulatory Frameworks Apply to Venture Capital and Human Rights?

Until recently, specific legislation regulating how vc investors must treat human rights due diligence considerations has been scarce, if not non-existent. In the past years, however, governments have adopted several regulations aimed at pushing corporations to think about human rights and esg considerations in their daily operations. Even if some of these regulations do not apply directly to vc investors, they will have an indirect effect on their business practices and must be analyzed to understand how the vc industry might evolve.

Moreover, vc firms’ activity is multinational by nature. For example, vc firms usually raise capital from investors all over the world, have offices in one or more countries, incorporate their funds in tax friendly legislations and invest in startups based in different regions. Establishing the precise framework applying to a specific vc firm can therefore be challenging. For more clarity, the present analysis will be limited to the regulations applicable to vc investors located and investing in Europe and Switzerland.

First, vc investors are subject to the United Nations Guiding Principles on Business and Human Rights (“ungps”). In theory, they must therefore adopt the human rights due diligence mechanisms described under principles 17 to 21 of the ungps. However, as the ungps only provide general guidance, they may not be suitable to serve as the common guidelines the vc industry needs. Their influence in the actual decision-making process remains weak.²⁴

The Organization for Economic Cooperation and Development (“oecd”) adopted a due diligence guidance for responsible business conduct (“oecd Guidance on rbc”),²⁵ which further details the obligations set out in the ungps. The oecd Guidance on rbc is aimed at offering practical actions in order to implement hrdd.²⁶ In addition, the oecd adopted a sector-specific guidance for institutional investors which lays out principles in the finance sector specifically. Both sets of documentation offer vc investors an overview of the key considerations they should take into account in their investment processes as well as practical actions to be implemented.

On the regional level, the European Union recently committed to improving how European financial institutions integrate sustainability into their operations by adopting specific sets of regulations.

In particular, the European Union adopted the Sustainable Finance Disclosure Regulation (“sfdr”), which aims at implementing transparency with regards to the integration of sustainability risks by financial market participants, including vc funds, and the consideration of adverse sustainability impacts in their processes.²⁷ The sfdr specifies disclosure levels for financial institutions claiming to take into consideration esg factors in their investment thesis (“light-green funds”) and those which claim to seek a positive impact (“dark-green funds”). As a result, vc investors are required to measure the sustainability of their investments, including human rights considerations.

In addition to the sfdr, the European Union adopted the EU Taxonomy, which aims at setting common criteria for determining whether an economic activity qualifies as sustainable²⁸ by defining six environmental objectives which an investment must contribute to and not significantly harm to be deemed sustainable. Furthermore, the EU Taxonomy states that any investment deemed as sustainable must comply with the oecd Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.²⁹

The European Union also introduced the Corporate Sustainability Reporting Directive (“csrd”) with the purpose of improving the transparency regarding certain sustainability information of corporations. It unifies and provides mandatory guidelines on the reporting of non-financial sustainable metrics. In particular, such corporations must allow an assessment of how they impact climate change (inside out) and how climate change impacts them (outside in). The csrd is only applicable to large undertakings which exceed at least two of the following criteria: eur 50 million in net annual turnover, eur 25 million in assets, and/or 250 or more employees. Small and medium sized companies are also subject to the provisions set out in the csrd if they are publicly traded. In the context of the vc market, most startups and most vc firms will fall short of meeting these conditions, and therefore the direct impact of the csrd on the vc market is limited. However, the indirect impact of that regulation remains to be seen; it may very well set new standards in the vc industry.

Finally, the Corporate Sustainability Due Diligence Directive (“csddd”)³⁰ was adopted in April 2024.³¹ While the csrd and sfrd primarily focus on transparency and reporting obligations, the csddd requires companies to actively mitigate their adverse impacts on human rights and the environment. Companies within the scope of the csddd must conduct due diligence on their own activities and assess the impact of their upstream and downstream operations.³² However, the number of companies affected by the csddd will be limited, as it applies only to European companies with more than 1,000 employees on average and a net worldwide turnover exceeding eur 450 million in the last financial year.³³ Non-European companies will also fall under the csddd if they generate a turnover of more than eur 450 million within the EU, without needing to meet a specific employee threshold.³⁴ Additionally, companies providing services rather than products are not required to conduct due diligence on their downstream activities and business partners.³⁵ The EU Commission is still evaluating whether specific due diligence requirements should be established for financial institutions and companies offering financial services and investment activities.³⁶ Consequently, the impact of this regulation on the vc industry remains to be determined. Moreover, few vc firms are likely to meet the thresholds required to be subject to the csddd.

In Switzerland, the adoption of regulations promoting broader implementation of human rights due diligence practices has been slow. In response to the Responsible Business Initiative, a citizen initiative, the Swiss parliament adopted articles 964a to 964l of the Swiss Code of Obligations (“sco”) in 2020. These articles establish a series of transparency obligations regarding non-financial matters.³⁷ Under these provisions, companies must report on their CO₂ targets, social issues, employee-related issues, respect for human rights, and efforts to combat corruption. However, this regulation only applies to public companies, corporations with at least 500 full-time equivalent positions, or those exceeding either a balance sheet total of 20 million Swiss francs or a sales revenue of 40 million Swiss francs. Additionally, sector-specific regulations apply to companies involved in the mining and trade of certain minerals, or those offering products or services suspected of being manufactured or provided using child labor. These companies must implement due diligence processes for their supply chains. Given the size and industries in which startups operate, few will actually be affected by these regulations. However, on the 26th of June 2024, the Federal Council opened consultation proceedings pertaining to the introduction of a new regulation aimed at strengthening transparency obligations and widening the range of corporations that would be subject to such obligations³⁸. Even if the exact outline of the regulation remains to be seen, this signals a desire from the Federal Council to align with the EU on this topic.

The regulatory framework outlining the rules that venture capital investors must follow when implementing human rights due diligence remains relatively lenient and lacks many mandatory provisions. Except for the csddd, regulators have focused primarily on increasing transparency, particularly towards a fund’s investors (which, in the context of vc investing, are the lps). However, the current regulatory framework can serve as a step forward in encouraging vc investors to consider human rights in their investment decisions and to disclose their stance on these issues. Additionally, these regulations may provide the common ground needed within the vc industry.

3.1 What Measures Can Venture Capital Investors Implement?

When they set up an investment fund (fundraising) and start screening the market for potential candidates (sourcing), vc investors need to have in place a clear investment strategy embedding human rights considerations, which is fully supported by, and communicated to, the lps. Once a target has been identified, the initial due diligence exercise should be conducted in a way that allows adequate identification of potential human rights issues and related remedial measures. Of course, the terms of any investment should be negotiated in a way to ensure a shared vision, mission alignment and proper governance and transparency regarding human rights issues within the stakeholders. Once the investors close the deal, continuous management and monitoring on progress should be implemented. Finally, human rights compliance should also be part of the discussion investors have when they go public or sell their stake to new investors (exits). Throughout this process, vc investors must appropriately document the measures they are taking to make sure that their own activity does not create adverse human rights impacts.