Introduction
In a world where sustainability is shaping the heart of corporate strategy, the story of an energy firm's decision to divest its gas infrastructure in 2016, and again in 2020, shines a spotlight on the shifting priorities of investors. The energy firm noted a higher level of investor attention to the environmental aspects of its gas assets in 2020 compared to 2016. 1 This highlights the growing influence of Environmental, Social, and Governance (ESG) considerations in shaping business deals.
In today's business landscape, ESG factors have shifted from being nice-to-have add-ons to essential elements of successful mergers and acquisitions (M&A). Sustainability and social responsibility are more than just buzzwords—they're integral to creating value and resilience in today's market. According to a global survey by Deloitte, 60% of dealmakers across the world now view ESG as a critical factor in their investment decisions.2 This trend is not confined to any single geography; from Nigeria to the Northern Hemisphere, the wave of ESG integration into M&A strategies is gaining momentum.
The Growing Role of ESG in M&A: What You Need to Know
The global landscape is changing: regulatory pressures, investor preferences, and societal expectations are pushing ESG to the forefront of business considerations. Regulatory bodies are increasingly mandating transparency and ESG compliance, driving companies to incorporate these considerations into their strategic planning and reporting. For example, regulations like the EU Sustainable Finance Disclosure Regulation (SFDR) highlight the trend towards sustainability, requiring financial market participants to disclose how they integrate ESG risks in their investment decisions.3
Investors are increasingly channeling funds into businesses that prioritize ESG, recognizing that such businesses often yield better long-term returns and exhibit stronger resilience against risks. For instance, Helios Towers' acquisition of SA Towers in South Africa was crafted with ESG considerations, aiming to foster the sustainable growth of telecommunications infrastructure while minimizing the carbon footprint by promoting the shared use of towers. Similarly in Nigeria, Access Bank has been active in incorporating ESG considerations into its investment decisions. Its acquisition of Transnational Bank in Kenya was part of its broader strategy to champion sustainable banking practices across Africa,4 demonstrating how ESG principles are being integrated into M&A strategies beyond mere compliance, but as part of a deliberate strategy to drive sustainable development.
Why should this matter to you? As ESG considerations become increasingly important to stakeholders and shareholders, they present both financial and reputational risks in the context of M&A transactions. In some cases, negative ESG-related issues found in due diligence may cause the investors to seek renegotiation on the deal terms; in other cases, the issue may be so fundamental that it blows up the whole deal immediately. The message is clear: incorporating ESG criteria into M&A strategies is no longer simply about meeting regulatory demands—it's a strategic imperative that distinguishes forward-thinking companies and aligns them with future market directions.
Integrating ESG Across the M&A Lifecycle: From Initial Consideration to Post-Closing Integration
ESG considerations are relevant from the early stages when a transaction is merely being contemplated and remain relevant through the due diligence process, negotiation of the definitive agreement, and up to and post-closing.
Initial Consideration Phase: ESG considerations are increasingly becoming a critical filter for investment decisions. Investors are closely examining the ESG performance of potential targets, recognizing that strong ESG credentials not only reduce risk but also enhance the attractiveness of an investment. This scrutiny is common in regions with significant environmental and social challenges. For example, in Brazil, a company's stance on environmental issues like unsustainable logging or the effects of climate change in the Amazon rainforest significantly affects its appeal to international investors. Entities need to align their practices with ESG standards to attract investments and facilitate transactions smoothly.
Due Diligence Phase: The due diligence process has expanded to include a thorough evaluation of ESG aspects, acknowledging their direct impact on transaction value and associated risks. This stage involves assessing the target's compliance with ESG-related regulations, its environmental footprint, social practices, and governance structure. There's a growing focus on ensuring the target's ESG claims are genuine to avoid greenwashing and to ascertain that the business' operations align with broader stakeholder expectations and sector-specific standards.
Both buyers and sellers should consider the following during the due diligence process:
- Does the target company have a clear ESG strategy?
- What specific ESG policies, procedures, and processes are in place?
- To what extent is the company's board involved in the ESG strategy, including holding management accountable?
- Which ESG factors are crucial for the company's operational success?
- How do ESG considerations affect stakeholder perceptions and decisions regarding the company?
- Is there a strategy for engaging with stakeholders, and what is the history of such engagement?
- Has the company produced internal or external reports on its ESG performance?
- What actions have been taken to mitigate ESG risks?
- Are adequate resources allocated to manage ESG issues effectively within the company?
Negotiation Phase: Although the explicit inclusion of ESG clauses in M&A agreements is not yet common in all jurisdictions, there is a noticeable trend towards incorporating ESG considerations into the legal framework of transactions. Transaction documents are increasingly featuring representations and warranties that address ESG concerns. This negotiation stage is crucial for embedding ESG principles into the agreement, laying the groundwork for future compliance and alignment with ESG objectives.
Post-Closing Integration: After the transaction concludes, the focus shifts to integrating the ESG findings from due diligence into actionable strategies. This involves aligning the acquired company's operations with the acquirer's ESG objectives, operationalizing improvements, and ensuring the realization of sustainable, long-term value.
Key Insights into ESG Representations and Warranties
Representations and warranties have become essential tools for addressing and mitigating ESG-related risks. These legal provisions are crafted to ensure that a target company adheres to relevant ESG regulations, engages in sustainable practices, and upholds ethical governance standards. The coverage of ESG factors in these clauses includes environmental compliance, social practices, and governance standards, offering a comprehensive framework for assessing the ESG performance of the target company.
For buyers, ESG representations and warranties are not just about risk mitigation; they provide a strategic advantage by uncovering potential ESG-related liabilities and opportunities for value creation. These provisions enhance the due diligence process, allowing for a more informed assessment of the target's operations, and can lead to more favorable deal terms. They enable buyers to identify companies with robust ESG practices, which often correlate with resilience, long-term performance, and innovation.
Sellers, on the other hand, leverage ESG representations and warranties to demonstrate their commitment to sustainability and good governance, thereby enhancing their appeal to potential buyers and potentially commanding higher valuations. By proactively addressing ESG issues, sellers can streamline the due diligence process, minimize the risk of deal disruptions, and bolster their reputation among stakeholders.
Actionable Strategies for Maximizing ESG Value in M&A
- For Buyers: Implement comprehensive due diligence to understand ESG risks fully, be vigilant against greenwashing, and use ESG performance as a litmus test for the target company's overall operational integrity.
- For Sellers: Prepare thorough ESG disclosures, establish mechanisms to monitor and uphold ESG commitments, enhance ESG ratings, and articulate a compelling ESG narrative to prospective buyers.
Risk-Mitigation
ESG considerations are more than just a fad; they present both challenges and opportunities, highlighting the strategic importance of ESG considerations in enhancing due diligence and mitigating risks. The journey towards fully integrating ESG into M&A is ongoing, but its direction is clear: a future where business success is inseparable from environmental stewardship, social responsibility, and ethical governance. Mitigating ESG risk and maximising ESG-related synergies in M&A transactions have therefore become an important consideration for companies.
Supporting Businesses through ESG Integration in M&A
ESG considerations are becoming indispensable in modern M&A transactions, serving as both a risk management tool and a means of unlocking value. At SimmonsCooper Partners, we recognize the complexities involved in embedding ESG considerations into M&A strategies. In a time when corporate accountability is more critical than ever, our guidance is essential for leaders aiming to manage risks and steer through the complexities of sustainable business practices.
For guidance on incorporating ESG principles into your M&A transactions, please contact Oluwadara Omoyele or Oluwadolapo Owoyokun
Footnotes
1 Better decisions for deal value: Optimising transactions with enhanced insights | Aon's C-Suite Series
3 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector. Accessed on 19th February 2024 from https://eur-lex.europa.eu/eli/reg/2019/2088/oj
4 Access Bank Sustainability Report, 2020 https://sustainability2020report.accessbankplc.com/report/#section-1
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