The Growing Imperative of Sustainability in M&A

Sustainability has been a hot topic in M&A during the recent years as more and more companies have begun to recognize the impact of sustainability factors to their operating environments. The reason behind the rise of sustainability is simple and perhaps a bit gritty; studies have found that companies that are focused on sustainability are more likely to better manage environmental, financial and reputational risks. This is likely to lead to a better valuation on the company over the long term.

“It is self-evident that the need to address sustainability issues in M&A is only becoming more important in the face of expanding government attention, low-carbon economy, growth of responsible investment, and greater media exposure of sustainability issues.”

It is self-evident that the need to address sustainability issues in M&A is only becoming more important in the face of expanding government attention, low-carbon economy, growth of responsible investment, and greater media exposure of sustainability issues. This growing imperative of sustainability issues in M&A is forcing the buyers to gain a deeper understanding how the business models and strategies may be impacted in the long run and how to manage and mitigate the risks associated with them.

In M&A transactions, “ESG” – environmental, social and governance – is a commonly used interchangeable term for sustainability. As the term ESG well demonstrates, the spectrum of ESG issues is broad including e.g. pollution and contamination, treatment of employees, equality and diversity, human rights, anti-bribery, and corruption. These multifold ESG issues may have a significant effect on the viability and the ultimate value of a transaction. Because the amount of different possible ESG risks may sometimes feel paralyzing, the buyers need to be aware of the material ESG factors for the target’s business operations and carefully determine how to approach them in the course of a deal. This assessment must be made in all transactions – gone are the days when buyers raised sustainability issues mainly in transactions related to the consumer sector.

What to Keep in Mind?

1 Generic Risk Assessment
ESG issues may not be easily identified and the examination of such issues might require a burdensome thorough analysis. Therefore, it is crucial that a buyer first identifies the generic risks that are relevant to the transaction on the basis of the target’s geography, industry, and operations. Although certain industries, such as companies in consumer and energy sectors, are more prone to ESG risks, it is important to bear in mind that some ESG issues are universal. In fact, there might be even a greater need to ensure that ESG issues receive a systematic consideration in sectors where ESG risks have been seen as a less business critical in the past – even if only to be ruled out at a later phase.

2 Due Diligence
After the general risk assessment, the buyer should review the target company’s capability to address and manage ESG risks by reviewing its codes of conduct, policies, processes, and consciousness of ESG issues. By comparing the generic risks to the target’s risk management, a buyer is able to assess whether the target entails ESG risks or risen potential. In case the assessment reveals material ESG risks, the buyer should consider detailed due diligence and if necessary, consulting technical or local expertise.

3 Leverage in SPA Negotiations
Contractual protection against ESG risks can be very limited, if not non-existent. ESG risks are often dependable on the actions of the target’s business partners and a seller may be reluctant to give any indemnities related to third parties. However, ESG factors can be put into the SPA as a price negotiation tactic. Although the seller is unlikely to accept such clauses, it can be used as a lever to negotiate the price or to get more detailed information on the possible ESG issues.