ESG and M&A

Origo’s founder Jussi Majamaa explains how considering sustainability in M&A creates shareholder value.

14.6.2023 (Helsinki, Suomi) – Origo Partners Oy

Environmental, social, and corporate governance (ESG) is rapidly becoming front of mind for regulators, investors, customers, and employees—and it is rising to the top of corporate agendas as well as corporate directors are challenging their M&A teams to consider targets that advance the organization’s pursuit of sustainability. 

Success begins by linking overarching corporate ESG strategy to M&A strategy. It means making sustainability a part of each deal thesis. It means using corporate priorities as a benchmark to assess each potential deal and find assets that will advance existing ESG initiatives as well as create economic value. 

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. 

Here’s how M&A and ESG intersect:

Target selection – ESG factors are increasingly influencing how companies select potential targets and business partners. 

These considerations impact companies’ decisions to divest certain assets, while others may opt not to engage with a target company with a weak ESG track record. 

To the extent that higher ESG scores remain consistent with higher market valuation, larger, more efficient companies, and those that have been at the forefront of ESG practice, may be able to utilize their ESG expertise to acquire a “lower” performer as part of a transaction.

There is also a growing recognition of new business opportunities across industries and that partnering with companies with strong ESG profiles, such as businesses focused on renewables or which have a strong record of innovation, can enhance a company’s ability to deliver long-term sustainable value to its stakeholders. 

For those who can get it right, the rewards are high. Targets with strong ESG profiles are very sought after by corporations and private equity alike, and richly valued. The ongoing shift in capital allocation will just increase the valuation gap in future. For some industries, the effect could be dramatic. 

Due Diligence. ESG will continue to be an increasing concern in transaction due diligence. As a starting point, acquirers are evaluating the ESG risks and opportunities in the target’s business against their ESG policies to compare the level of alignment with their ESG strategy. As a result, it is becoming increasingly common, even for private companies, to be mindful of their ESG practices generally and to prepare ESG information at the early stages of a deal, as potential buyers are likely to evaluate the target’s ESG practices.

Certain key ESG risks—notably, risks related to corrupt business practices, privacy and data security, climate change, greenhouse gas emissions, diversity and labor practices—are already being evaluated in the context of M&A due diligence, as is the more general consideration of the potential impact of an acquisition on the reputation, culture and integration of the combined company. Acquirers are interested in whether the target’s current business practices will be regarded favorably by stakeholders (principally investors and customers) – particularly in relation to supply chain, emissions, and modern-day slavery. Other considerations include whether the target complies with the ‘soft law’ or industry standards expected for their sector, whether the target has made climate-related claims that can be validated, and if such claims cannot be validated, what risks do the acquirers face regarding greenwashing claims. Acquirers will also want to question whether the target has completed its due diligence as it relates to suppliers and other third parties. They will also want to review underlying contracts to assess whether appropriate clauses and warranties are included in supplier/third-party contracts.

Governance and integration. In the M&A context, the consideration of ESG factors and related metrics and the broader concepts of stakeholder governance and corporate purpose are entirely consistent with traditional conceptions of directors’ duties. A company’s broad positioning on ESG matters, including its policies and approaches and its quantifiable successes and failures in managing sustainability, human capital and other ESG concerns, will prove insightful into a company’s culture, and an important determinant of whether it is a suitable target or partner. Similarly, companies with noticeable differences in their ESG performance will need to consider whether such differences would hinder their ability to fully realize expected synergies from a potential combination, or otherwise increase integration challenges.

Financing and cost of capital. Companies with strong ESG performance may be seen as less risky and more sustainable, which can result in lower borrowing costs. Lenders and investors are increasingly offering favorable terms to businesses with good ESG track records and financial markets have witnessed the rise of ESG-linked financing instruments, such as green bonds, social bonds, and sustainability-linked loans. These instruments provide specific financing for projects or activities that meet predefined ESG criteria. They enable companies to access capital for ESG-related initiatives or provide financial incentives to improve their ESG performance. Banks have sustainability targets too, which may affect your plan for acquisition financing. For instance, Nordea’s mid-term objective for 2030 is to reduce carbon emissions across its lending and investment portfolios by 40-50% compared to 2019. Since 2019, Nordea has cut oil, gas and offshore activities lending by more than 70%. 

Conclusions. To summarize, taking ESG seriously will increase the demand and number of potentially interested buyers and increase valuation. As your professional financial advisors, we will guide you through the sales process, taking a close look into ESG matters and ensuring that the value will be maximized. Preparation is often the key as any policies will take time to implement. Our work on exit strategy can start several years before the sales process and involve identifying issues within the business and agreeing a strategy to make the business more attractive to prospective purchasers. Shareholder value can be maximized by making the right strategic moves ahead of an exit.