Sustainability has risen to the top of investors and corporate leaders’ M&A agenda as ESG (environmental, social, and governance) issues have become a critical part of both the investment thesis and the deal value capture of individual acquisitions.
ESG due diligence: identifying sustainability risks and finding and capturing value creation opportunities
The emphasis between environmental, social, and governance aspects in a single due diligence varies highly as each acquisition case is dependent on the type of material for the company, its industry and the markets in which it operates in. Hence, focus on the most material issues is critical to avoid boiling the ‘infamous ocean’. However, this can be a devastating task without access to professionals with a multidisciplinary understanding of often seemingly unrelated topics or the ability to benchmark the state of target’s operations both globally and locally.
Many companies and investors have already started to use external advisors to conduct due diligence on their acquisition targets’ sustainability issues. However, only a few have looked beyond the material risks that most reports focus on. This is not at all surprising! The cause-effect relationship between material ESG issues, i.e., non-financial and financial metrics is rarely self-evident or easily quantifiable. This does not mean that it couldn’t be reasonably probable to find a link between ESG and financial value creation since many market trends are already indicating it.
Investors demand ESG disclosures
The EY Investor Survey in 2020 already indicated that firms failing to meet investor expectations on ESG factors risk losing access to capital markets. This has led investors to demand ESG disclosures. While ESG performance has become a guiding factor to avoid ‘unsustainable companies’ for some investors, others have taken steps towards impact investing by seeking targets with already high ESG performance and high future potential.
One of the core challenges for most investors and acquirers remains the lack of comparable ESG performance figures and reasonable certainty to assess the target. Luckily for the investors (although burdensome for most companies), the increasing number of sustainability regulations (e.g., EU taxonomy, CSRD) are about to provide some long-needed comparability. Though, this still might not necessarily be in as clear a format as comparing financial metrics between companies’ financial reports.
Investors and acquirers are becoming eager to identify the sustainability-driven financial value in acquisitions. This is a cause-effect relationship arising as the ESG performance of companies is gradually becoming more transparent and standardized. Such value may originate for example via:
- Shifting value drivers on customers’ willingness to pay for sustainable offerings
- Lowering customers green premiums via target’s handprint capabilities
- Attracting and retaining diverse and sought-after talent
- Inducing lower costs of capital via strong ESG performance