What To Watch: ESG In Mergers And Acquisitions – Corporate/Commercial Law

In the world of mergers and acquisitions (“M&A”), both buyers and sellers place more value on environmental, social and governance certificates (“ESG”).

ESG criteria are reporting practices used by companies and are “a set of standards for conducting a company that socially conscious investors use to review potential investments.” 1 Companies that are about to be sold (“Sellers”) can use ESG metrics to add value to their business. Likewise, private equity firms, multinational corporations, and other buyers (“Buyers”) looking for the right acquisition target (“Target”) can use the same metrics to assess targets and reduce reporting requirements. As ESG continues to grow in importance in M&A transactions, both buyers and sellers (“dealmakers”) are realizing that ESG recognitions are no longer sources of risk reduction, but rather sources of value.

Sellers can use ESG metrics to determine the valuation of their business. In a podcast moderated by McKinsey, Sara Bernow, who leads McKinsey’s work on sustainable investing and co-head of institutional investment practice in Europe, explained the “reason”
[ESG] What matters in M&A situations is that more and more research shows a positive correlation between ESG performance and financial performance or value creation. ”2 The ability to define a competitive and market-driven price is of crucial importance for sellers. In addition, assessing known, potential, and contingent liabilities enables sellers to identify and mitigate risks prior to entering into a sales transaction. Sellers can be more confident that these risks will not reduce their rating. In the M&A industry, “a company’s failure to understand and properly account for key ESG factors in its business is increasingly viewed as a significant risk to the company’s long-term value.” 3 Buyers can choose the price of the Lower transaction as soon as they discover ESG liabilities.

Likewise, buyers who analyze ESG metrics can better assess the value of their target. Companies are increasingly tracking ESG measures and risks and reporting on these findings. In fact, disclosure increased more rapidly between 2019 and 2020 than any year before.4 Such reports may reveal environmental trends or other legal risks that might not otherwise appear on a due diligence list.5 For example, the ability of a target to adapt in a Environmental crisis. The M&A industry will continue to view ESG risk as an important transaction factor, as “as the value of losses and damage from climate change is likely to increase litigation risk.” 6 ESG reports also inform buyers of ESG opportunities that the target has resource efficiency and cost savings, access to new markets and resilience in the supply chain.

Despite the lack of a standardized ESG eligibility framework, buyers can compare the rating of targets based on ESG criteria. Even if ESG metrics are not measured identically, disclosing quantifiable information allows buyers to find common ground and compare goals within and across industries.7 This gives buyers a better understanding of how different goals are compared. Many organizations, such as the Task Force on Climate-Related Financial Disclosures and the Global Reporting Initiative, have also issued their own recommended guidelines on ESG best practices. These existing ESG frameworks can be useful base metrics for buyers.

National and supranational institutions now require ESG reporting measures for investment companies, listed companies and companies in certain industries.8 Not only targets or sellers have a reporting obligation, but buyers may also have to report on ESG metrics. In such cases, buyers are also required to report ESG metrics for their store as well as any stores they have acquired. This reporting effort is eased when buyers acquire targets that already provide ESG measurements, which makes it easier to comply with national and supranational requirements

Both buyers and sellers should consider the impact of ESG reporting on M&A transactions and the best way to be careful about those impacts. There is no one-size-fits-all approach to ESG diligence. However, effective ESG diligence helps deal makers “have a clear understanding of the business, the business plan, the ESG implications and risks, and how management can address or leverage these issues.” The information gathered can facilitate effective due diligence – that is, aligning due diligence requirements with ESG reporting requirements. More detailed ESG diligence queries trigger responses from the target that identify liabilities and risks that might otherwise not have been identified. Developing an ESG policy is a common way of structuring the process for ESG due diligence, as a policy creates a streamlined and consistent process for companies

While ESG has traditionally been overlooked in the M&A world, dealmakers are recognizing its inevitable rise in importance.12 Sellers doing ESG diligence improve their company valuation and competitive market prices, while buyers are able to better evaluate their goals and reduce reporting effort to reduce. Both buyers and sellers benefit from the value creation from ESG metrics instead of perceiving ESG as exclusively risk-based.

Footnotes

1. The Investopedia Team, Environmental, Social, and Governance (ESG) Criteria, Investopedia (March 5, 2021), https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria .asp.

2. Robin Nuttall, Director of Regulatory and Government Affairs at McKinsey said, “There have been more than 2,000 academic studies and around 70 percent of them find a positive correlation between ESG scores and financial returns, whether measured by Stock returns, profitability, or valuation multiples. Another element is increasingly the cost of capital. There is growing evidence that a better ESG score means about 10% lower cost of capital than the risks that affect your business. its operating license will be reduced if you have a strong ESG promise. “See Why ESG is here to stay, McKinsey (May 26, 2020), https://www.mckinsey.com/business-functions/strategy-and-corporate -finance / our-insights / why-esg-is-here- stay.

3. G. Casey, D. Lillienfield, M. Mezey, P. Strecker, M. Behrens, ESG Considerations in M&A, Corporate Board Member, https://boardmember.com/esg-considerations-in-ma/ (last visited 11/18/2021).

4. Michael R. Bloomberg, TCDF Status Report (2021), Task Force on Climate-related Financial Disclosures, 1-115 (October 2021), https://www.fsb-tcfd.org/publications/.

5.ESG Due Diligence, cdc Investment Works, https://assets.cdcgroup.com/wp-content/uploads/2018/12/21165801/5.-Investment-cycle-Due-diligence.pdf (last visited on 18. November 2021).

6. Michael R. Bloomberg, Recommendations of the Task Force on Climate-related Financial Disclosures, Task Force on Climate-related Financial Disclosures, 5 (June 2017), https://assets.bbhub.io/company/sites/60/ 2020 /10/FINAL-2017-TCFD-Bericht-11052018.pdf.

7. Andrew R. Brownstein, David M. Silk and Sabastian V. Niles, The Coming Impact of ESG on M&A, Harvard Law School Forum on Corporate Governance (February 20, 2020), https: //corpgov.law.harvard. edu / 2020/02/20 / the-coming-impact-of-esg-on-ma /.

8. ESG Due Diligence, dentons (November 13, 2019), https://www.dentons.com/en/insights/articles/2019/november/13/esg-due-diligence; Brownstein, Silk & Niles, see note 7.

9. ESG on the Rise: Making a Impact in M&A, his markit and Merger market, 1-13 (May 6, 2019), https://www.mergermarket.com/assets/Ipreo%20Q1%202019%20Newsletter_AW_FinalLR.pdf .

10. Helee Lev, ESG Due Diligence – How it’s done & why, goby (March 23, 2021), https://www.gobyinc.com/esg-due-diligence-how-and-why/.

11. Trysha Daskam and Fizza Khan, Best Practices in ESG Due Diligence for Private Equity Firms, silvervision (November 5, 2019), https://silverregulatoryassociates.com/insights/best-practices-in-esg-due-diligence-for -Private Equity Firms /.

12.ESG on the rise: M&A impact, see Note 9.

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