industries with high regulatory risk, such as coal mining, fossil fuels, or weapons manufacturing, run the risk of new regulations limiting their growth opportunities. Companies operating in industries with high reputational risk, such as tobacco or gambling, face significant risk of lower growth prospects as regulators restrict sales and marketing practices and customer behavior and sentiment changes. Companies operating in high political risk countries such as Iran, North Korea, and disputed territories such as Western Sahara also face significant risk as political sanctions can suddenly close the end market. It's not just the big sustainability factors that can affect a company's growth, but important social factors can also have a major impact on a company's growth prospects. Unsustainable material sourcing or not developing human capital are examples of major social factors that can limit a company's growth. Companies that do not have a sustainable supply chain run the risk of disruptions or increased costs for inputs. Companies that do not develop and invest in their human capital may not be able to attract the best employees and have high sick leave or turnover. At REQ Capital, we always analyze a wide range of social and environmental factors that can influence growth as part of our investment analysis. Sustainable growth is at the heart of our investment philosophy and is therefore an integral part of our investment process. This is also one of the reasons why we invest in serial compounders. Serial compounders own several small portfolio companies, each operating on a stand-alone basis. Typically, no subsidiary accounts for a significant portion of the parent company's total revenue, and the subsidiaries operate in different geographies and/or industries. The parent company makes high-level strategic decisions and acquires companies that fit the company's strategy, including sustainability attributes. This business model ensures that sustainability is embedded throughout the organization. Sustainability and the cost of capital There is no doubt that sustainability also affects a company's cost of capital, through higher costs of equity and debt. If a company does not take sustainability into account, it risks lower growth prospects, which increases the cost of capital. The allocation of capital also has a major impact on a company's cost of capital. The introduction of the EU taxonomy in Europe and several initiatives by investors around the world have led to an increasing number of investors excluding certain industries or certain companies that do not meet certain sustainability criteria. This means that investors are withdrawing capital from companies that do not meet sustainability requirements. Companies that operate in such industries or do not meet certain sustainability requirements run the risk of having access to a smaller pool of capital, which increases the overall cost of equity. The above two factors also apply to the cost of debt, as companies with lower growth prospects face a higher risk of not being able to repay their debt. In addition, lower access to equity financing increases the risk for lenders. Moreover, the number of potential lenders is lower, as many lenders apply the same sustainability criteria. Consequently, the cost of debt also increases for companies that do not incorporate sustainability into their business model.
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