A significant milestone that will change the way companies worldwide, including startups, measure and publicly report their management and performance took place on June 26th.
The startup ecosystem understands the value of metrics very well for making management and investment decisions. In fact, many of the metrics used to evaluate startup performance, such as growth, are based on traditional financial indicators.
However, in a context where non-financial and non-market factors increasingly impact financial performance, success, and continuity, the business ecosystem and financial markets worldwide have recognized that traditional financial metrics fall short of providing the information needed to make strategic decisions about businesses and investments.
That’s why the International Financial Reporting Standards (IFRS) has developed the first set of Sustainability Standards, which complement their existing and widely adopted accounting standards. In this article, we will explain who the IFRS is, what the newly published standards are about, and how all of this relates to the startup ecosystem.
What is the IFRS?
The IFRS is the global standard-setter for financial information. It is the creator of the International Financial Reporting Standards, which are mandatory in most countries for the preparation and presentation of financial statements. In simple terms, it establishes the standards for measuring and reporting a company’s financial performance. In fact, many of the metrics used by startups are built upon indicators based on the IFRS, such as revenue, costs, margins, etc.
What are the IFRS Sustainability Standards and why were they created?
The increasing regulation on sustainability worldwide (over 150 sustainability regulations have been announced in the last 12 months) and the evidence that environmental and social aspects significantly affect a company’s financial performance have led regulators and investors to require companies to disclose risks to their business generated by these issues.
Many companies have voluntarily (and increasingly mandatorily) been reporting this information, and some investors have even created their own environmental and social questionnaires on issues that can impact investment returns. However, the information reported by companies is often insufficient, inconsistent, and incomparable.
Therefore, the IFRS has unified existing standards and created a global set of sustainability-related financial disclosure standards. This will align financial and sustainability information, providing managers with a more comprehensive view to make informed decisions and investors with a holistic overview of the companies they invest in.
“An entity shall disclose information that enables users of financial reports to understand its ability to adapt to uncertainties arising from sustainability-related risks.”
IFRS, S1
What effects will these standards have on the startup ecosystem?
In most countries, the preparation of financial reports under the IFRS is a mandatory legal requirement for companies. With the introduction of the IFRS Sustainability Standards in January 2024, countries will begin the process of incorporating these standards into their legislation, eventually making sustainability reporting mandatory.
In Latin America, countries like Colombia and Chile have taken the lead by requiring listed companies to report sustainability information based on international standards. It is anticipated that the rest of the countries in the region will follow suit in the coming months.
As the scope of regulation expands to cover not only listed companies but also the rest of the economy (similar to the mandatory financial reporting requirement), this will start to have significant effects on startups, including:
- Increased regulatory compliance: Startups will need to comply with more mandatory regulations. Are they prepared to do so, or will they require a significant adjustment to continue operating?
- Access to investment: Venture capital investors will increasingly require sustainability information. How will this impact startups seeking funding?
- Due diligence: Due diligence processes for achieving an exit will increasingly include sustainability elements. What should startups consider to achieve a successful exit?
In our next article, we will delve deeper into the effects of these standards on compliance discussions, investment access, and due diligence for startups. Don’t miss it!