ESG in M&A: Sustainability considerations in M&A deals
Discover how to integrate ESG into M&A and what ESG factors to consider.
The case for considering sustainability in M&A
Mergers and acquisitions (M&A) are a significant driver of corporate change and business growth. However, in recent years, there has been a growing recognition that M&A activity should also consider environmental, social, and governance (ESG) factors. This is because ESG factors can have a material impact on the long-term financial performance of companies.
Some of the threats that
poor ESG can pose include:
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Financial risks: Companies with poor ESG practices are more likely to face financial risks, such as regulatory fines, litigation, and reputational damage.
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Operational risks: Companies with poor ESG practices are also more likely to face operational risks, such as supply chain disruptions, labour unrest, and customer boycotts. ​
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Reputational risks: Companies with poor ESG practices are more likely to suffer reputational damage. This can make it difficult to attract and retain customers, investors, and employees.
On the flip side, companies with strong ESG practices are more likely to create long-term value for shareholders. This is because they are better positioned to manage risks, attract and retain talent, and build a strong brand reputation.
Types of ESG considerations in M&A
Here are some of the key ESG considerations that dealmakers are factoring into M&A:
Environmental
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Climate change: Assess the target company's exposure to climate change risks, such as physical risks from extreme weather events and transition risks from regulatory changes and carbon pricing.
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Pollution: Evaluate the target company's environmental impact, such as air and water pollution, and its compliance with environmental regulations.​
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Resource scarcity: Consider the target company's reliance on scarce resources, such as water and energy, and its efforts to conserve resources.
Social
Governance
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Board composition: Evaluate the target company's board composition, such as its independence, gender diversity, and experience.
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Executive compensation: Assess the target company's executive compensation practices, such as the ratio of CEO pay to average worker pay and the use of performance-based pay.
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Corruption and bribery: Evaluate the target company's anti-corruption and anti-bribery policies and its compliance with relevant laws and regulations.
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Labour practices: Assess the target company's labour practices, such as wages, working hours, and safety standards.
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Human rights: Evaluate the target company's human rights record, such as its treatment of workers, suppliers, and communities.
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Diversity and inclusion: Consider the target company's commitment to diversity and inclusion, such as its representation of women and minorities in its workforce and leadership.
Practical approaches to integrating ESG in M&A
Here are some practical approaches for integrating ESG in M&A:
Establish a clear ESG strategy and framework
The first step is to develop a clear ESG strategy that aligns with the company's overall business goals and objectives. This strategy should identify the company's key ESG priorities and establish a framework for integrating ESG considerations into all aspects of the M&A process.
Conduct comprehensive ESG due diligence
​ESG due diligence should be an integral part of the M&A process. This involves evaluating the target company's ESG performance on a range of factors, such as climate change, labour practices, and corporate governance. This can be done by reviewing the company's ESG reports, conducting interviews with key stakeholders, and using third-party data sources. More on this below.
Integrate ESG considerations into valuation
​Because ESG factors can impact the financial performance of a company, it is important to consider ESG factors when valuing target companies. This can be done by adjusting the company's discount rate or by using ESG-adjusted financial metrics.
Use ESG factors to negotiate deal terms
​ESG factors can be used to negotiate deal terms, such as price, contingent payments, and covenants. For example, the buyer may agree to a lower purchase price if the seller commits to achieving certain ESG goals.
Develop a post-merger integration plan that includes ESG considerations
​ESG considerations should also be factored into the post-merger integration plan. This includes identifying and integrating the best ESG practices from both companies, developing a plan to address any ESG risks or liabilities, and establishing a communication plan to keep stakeholders informed about ESG progress.
Establish ESG metrics and reporting
​Companies should establish ESG metrics that are relevant to their business and industry. These metrics should be tracked and reported on a regular basis to measure ESG performance and identify areas for improvement.
Train employees on ESG
​Employees should be trained on ESG issues and the company's ESG strategy. This will help to ensure that ESG is embedded in the company's culture and that all employees are aware of their role in achieving the company's ESG goals.
Engage with stakeholders
​Companies should engage with a range of stakeholders, including investors, employees, customers, and NGOs. This will help to ensure that the company's ESG strategy is aligned with the expectations of its stakeholders.
Conducting ESG due diligence
Undertaking ESG due diligence is much the same as performing other types of due diligence in M&A. It’s the process of collecting and reviewing information pertaining to the target company’s ESG.
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Learn more: ESG due diligence
Steps
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Define the scope of ESG due diligence
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Collect ESG info on the target company
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Assess ESG performance
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Identify ESG risks and opportunities
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Develop ESG recommendations