Environmental, Social, and Governance (ESG) considerations in acquisitions have shifted from being a niche concern to a central factor in decision-making. As sustainability, social responsibility, and good governance increase in importance, investors are evaluating a target’s environmental impact, social policies, and governance structures to ensure that their investments have long-term value.
The Rise of ESG Due Diligence
Investors emphasise sustainability and ESG factors in their investment decisions, increasing the importance of ESG due diligence during mergers and acquisitions (M&A). According to KPMG’s 2024 Global ESG Due Diligence Study, 71% of respondents reported an increased focus on ESG considerations in transactions.
ESG due diligence involves assessing a target company’s environmental practices, social policies, and governance frameworks as part of the acquisition process. This can range from evaluating carbon emissions and waste management to examining labour practices and board diversity.
Incorporating ESG factors during due diligence helps acquirers identify potential risks and opportunities. Whether understanding environmental liabilities or scrutinising governance practices, ESG assessments provide a comprehensive view beyond traditional financial metrics.
Investors demand more transparency on how companies manage ESG risks and whether that organisation will post a reputational risk in the future. Consequently, acquirers look beyond the traditional due diligence mechanisms to understand how a company’s ESG profile might impact its long-term value.
With ESG being a core part of winning business through tendering, there is also a long-term underlying financial benefit for investors doing the legwork on ESG due diligence. Companies that demonstrate how they positively impact the environment and their communities will be more successful in tendering and generating a return on investment.
Key ESG Factors in Acquisition Strategies
Environmental Considerations
Assessing the target’s environmental practices, such as carbon footprint, waste management, and energy use, is vital. Companies with strong environmental credentials can enhance the acquirer’s overall ESG profile.
Social Responsibility
Explore how social factors, including employee welfare, community engagement, and supply chain practices, are scrutinised during acquisitions. Companies with positive social impacts often appeal more to investors and consumers, increasing their attractiveness as acquisition targets.
Governance Structures
Effective governance frameworks ensure that companies operate transparently and ethically. During acquisitions, governance structures are evaluated to mitigate risks and enhance decision-making processes, which are crucial for successful integration.
How ESG Can Influence Valuation in Acquisitions
Companies with strong, easily evidenced ESG credentials command a premium, as they are seen as lower-risk and aligned with future sustainability trends. For example, property investors see anywhere between 8% and 18% sales price premium for a green-rated building in the real estate sector. Understanding ESG risks during acquisitions can help companies avoid future legal, regulatory, or reputational issues
That said, an investor may be willing to take a risk on an asset whose value can be improved by integrating robust ESG practices post-acquisition if they can see growth potential.
Practical Steps for Integrating ESG in Acquisition Processes
High on our list of practical steps for ESG due diligence are:
1- Establishing clear ESG benchmarks for potential targets to meet. This could be regarding mandatory performance, reporting, and policies. It may also be good to score anything above and beyond standard benchmarks, such as a B Corp target.
2 – Ensuring that the due diligence process includes a comprehensive review of the target’s ESG performance. Identify any red flags that could affect the acquisition’s success, such as environmental liabilities, supply chain issues, or governance lapses. It’s also worth looking for any obvious PR issues at this stage.
3 – Collaborating with stakeholders, including other investors, employees, and local communities, can help identify ESG concerns that may not be evident from the due diligence process alone. Early engagement ensures that all parties are aligned on sustainability goals.
4 – Planning for post-acquisition as it’s not enough to assess ESG factors pre-acquisition; businesses should also focus on integrating sustainable practices post-deal. Establishing a strong ESG framework within the acquired company can lead to long-term benefits, such as reduced operational costs, enhanced brand reputation, and improved employee morale and retention.
Considerations for those looking for investment
Here are three essential tips for businesses seeking investment when it comes to ESG due diligence:
1. Be Transparent and Prepared with ESG Data
Investors expect clear, accurate, and comprehensive ESG data to evaluate your business’s practices. It’s valuable to have robust systems to collect, manage, and report carbon emissions, energy use, employee diversity, and governance policies, to name a few. Transparency is key—acknowledge areas needing improvement and outline the steps you’re taking to address them.
2. Align ESG Goals with Investor Priorities
Understand what matters most to your potential investors. Research their ESG priorities and align your goals with their expectations. For example, if they prioritise carbon reduction, highlight your sustainability initiatives and progress toward net zero. If social impact is key, emphasise employee well-being programmes or community engagement projects.
3. Identify and Mitigate ESG Risks
Investors will uncover ESG risks as part of their due diligence, so in identifying potential vulnerabilities in your operations or supply chain is worthwhile. Conduct a self-assessment to uncover environmental liabilities, governance weaknesses, or labour issues. Develop a clear action plan to address and communicate these risks to investors.
The Future of ESG in Acquisitions
Whilst there’s a certain amount of political change and ESG scepticism, investors continue pushing companies to prioritise ESG in their acquisition strategies. ESG fosters better business practices and galvanises an asset, making it an attractive proposition.
Integrating ESG factors in acquisitions is no longer a choice but a necessity for companies looking to future-proof their investments. By incorporating ESG into due diligence, valuation, and post-acquisition strategies, businesses can mitigate risks, drive value, and meet growing demands for sustainability from investors, consumers, and regulators.
Looking to integrate ESG into your acquisition strategy? Our expert team can guide you through the process, from due diligence to integration, ensuring your investments align with your sustainability goals. Contact us today to learn more.
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