Companies must consider environmental, social, and governance (“ESG”) factors in their mergers and acquisitions (“M&A”) transactions to achieve maximum value and monitor risks. ESG matters are becoming increasingly significant in M&A transactions as businesses are facing mounting scrutiny and pressure for transparency on climate risk, social justice, sustainability, and corporate governance.
To address ESG considerations in the context of an M&A transaction. Buyers—including private equity funds and strategic acquirers—should conduct ESG-focused due diligence, allocate ESG risk in the transaction agreement, and perform post-close ESG integration. This article addresses factors contributing to the increased focus along with commentary on how purchasers can integrate ESG factors in their next M&A deal.
Importance of ESG in M&A
A focus on ESG can be a competitive advantage for companies, private equity funds, and other strategic acquirers. It assists organizations in creating value, mitigating risk, and becoming more resilient. Consideration of ESG factors in M&A transactions is undeniably rising. Bain & Company recently conducted a global survey that found 65% of M&A executives expect. Their own company’s focus on ESG to increase over the next three years. 11% stated that they currently regularly assess ESG extensively in the deal-making process. Failing to account for critical ESG elements can undermine success and lead to poor business outcomes.
Shareholders and investors are becoming increasingly attuned to ESG issues. By directing their investments to companies with comprehensive and established ESG disclosures. Shareholders and investors globally are a key driving force behind growing disclosure. Since ESG factors overlap with core corporate values, failure to address ESG issues may have a disproportionately negative reputational impact on a business. When considering a transaction, buyers should understand all ESG matters associated with the transaction. Evaluate how to mitigate any reputational risks, and ensure that processes are in place to monitor the business’s reporting method.
Directors have a fiduciary duty to act in the best interests of the corporation. Which has generally been thought of as a duty to act in the shareholders’ interests. The duty of care requires directors to exercise care and diligence. And the skill that a reasonably prudent person would exercise in comparable circumstances. To fulfill their fiduciary duties, directors must consider what will maximize shareholder value in the long term. Businesses must account for risks to achieve lasting commercial viability. Shareholders have been more vocal and involved in the governance of a business. Demanding changes to leadership and the board of directors. We are starting to also see examples of shareholders successfully removing directors as a result of their discontent with the company’s approach to climate change. This surge of ESG-related activity is driving corporations to urgently transform their core strategies.
Considerable shifts in consumer awareness, and spending patterns. Employee expectations, regulatory frameworks, and industry perception have prompted investors to reallocate a notable amount of investments in light of trends. Climate change has significantly impacted the operations and value of numerous companies, and we believe this trend will continue as the frequency and scale of natural disasters continue to increase. Natural disasters have caused an estimated US$280 billion worth of losses in 2021. ESG factors pose a real risk to shareholders now that losses are tangible and quantifiable, directly impacting M&A activity. Businesses must also consider the effects of financing. Access to capital for businesses may be limited by poor ratings and performance. Lenders and institutional investors have also made it clear that businesses must make ESG a priority or risk losing financing.
Across jurisdictions, also the regulatory landscape is steadily evolving. Regulators along with other oversight bodies also have been expending resources to monitor and create rules and guidance on ESG matters. For example, in Canada, the Canadian Securities Administrators (“CSA”) recently published guidance for investment funds on their disclosure practices as they relate to factors. The CSA has indicated that it will monitor related disclosure as part of its ongoing continuous disclosure review program.
The US Securities and Exchange Commission (“SEC”) is evaluating current disclosure practices of climate-related risks. Recently, the SEC also issued a press release on proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on business, operations, and financial condition. And certain climate-related financial statement metrics. ESG factors will be a key consideration for both the buyer and the target. As various regulatory bodies continue to also bring additional rules and regulations into force.
As companies, investors, and shareholders are also becoming increasingly conscious of social and environmental factors. It is critical to evaluate investment opportunities through a lens. For the foreseeable future. ESG-assessed M&A will be an important tool to generate growth and provide companies with a competitive edge. It will also be crucial in establishing stakeholder trust. For corporate and fund-based dealmakers, decisive steps are needed in risk reduction and long-term value generation. Organizations that also take initiative and embrace M&A will be better positioned to achieve sustainable growth and adapt to constantly evolving expectations.