The role of sustainability in all business operations is increasing. ESG themes are also an integral part of M&A and increasingly subject to thorough assessment in connection with acquisitions. Sustainability issues also define which target companies are attractive.
Investors and financiers have high expectations related to sustainability. A great deal of mandatory sustainability-related legislation already exists and regulation is expected to continue to increase. According to Dittmar & Indrenius Partners Hanna-Mari Manninen and Wilhelm Eklund, sustainability requirements affect all companies, although the legislation often directly covers only large companies or companies operating in the financial markets.
Legal issues play a central role in successful transactions and, thereby, also in addressing sustainability matters in the context of acquisitions. Sustainability questions frame the entire lifecycle of acquisitions, from target selection to exit. In November 2023, Dittmar & Indrenius and the FIBS (Finnish Business & Society) corporate responsibility network published a guide discussing sustainability in acquisitions from the legal perspective. The guide includes concrete examples on how the purchaser can take sustainability issues into account during the different stages of the acquisition.
Managing sustainability risks
Private equity investors, for one, need information on how the target company has dealt with sustainability issues. Assessing sustainability issues is crucial, as sustainability affects the company’s success, value-creation potential, operational sustainability and stakeholder trust in the long term.
“An acquisition target can only be attractive when sustainability issues are in order,” says Manninen.
According to Eklund, considering sustainability aspects in acquisitions contributes to the management of risks relating to, for instance, environmental, labour or tax issues. Assessing and understanding sustainability risks enables allocating and managing these risks in connection with acquisitions, either in the transaction documentation or otherwise.
Acquisitions supporting sustainability
Why is the sustainability of acquisitions currently such a topical theme?
Many companies are having to take a stand on the impacts of their own operations on global problems, such as climate change. Another example of a situation which places corporate ethics and responsibility at the top of management’s agenda is the withdrawal of companies from the Russian market. Furthermore, for an increasing number of companies, sustainability is at the very core of their operations and they endeavour to promote sustainable development goals through their own business and strategy. The need for a company to stay relevant and to safeguard its reputation also play an increasingly important role.
“Acquisitions can support sustainable development. In the big picture, this means that companies are part of the solution: all means are required to solve the global crises, such as climate change and biodiversity loss,” says Manninen.
Eklund adds that the sustainability of acquisitions has also become more topical due to increased regulation and new reporting requirements, including due to requirements from investors.
“Previously, ESG due diligence carried out in connection with acquisitions was often just a tick-the-box exercise. Nowadays, that’s no longer enough,” says Eklund.
The significance of ESG due diligence has increased, and the findings may affect the valuation, contractual terms of the acquisition and financing. Sustainability issues continue to have an influence on the company value and value creation also after the acquisition, as from an investor’s perspective, what happens in the company between the acquisition and exit is crucial.
In the future, due diligence will more strongly guide business operations also outside M&A when the proposed Corporate Sustainability Due Diligence Directive (CSDDD) requires the regulated companies to conduct due diligence on, and take responsibility for, adverse human rights and environmental impacts along their value chains. The Council and the European Parliament reached a provisional deal on the CSDDD on 14 December 2023.
Snowball effect leads equity investors to sustainable companies
According to Manninen, sustainability as a whole is becoming more legal in nature. New requirements are being introduced and the interpretations of existing regulation may change. There is no single law governing sustainability, but a collection of provisions from various sources that must be considered. Acquisitions are indirectly affected by, especially, the EU regulations related to reporting, i.e., the Sustainable Finance Disclosure Regulation (SFDR) and Corporate Sustainability Reporting Directive (CSRD).
“When, for example, large companies or investors must report on their sustainability, this information will also be required from the companies from those in their value chain. Capital will flow to sustainable companies and companies’ sustainability claims will be aligned with actual practices. In the future, the management of the company’s externalities will become more legal in nature and, in addition to reporting requirements, a process and measures to actually manage environmental and human rights impacts will also be required,” says Manninen.
According to Manninen, what makes acquisitions challenging in terms of sustainability is that sustainability and key ESG issues of companies must always be defined while taking into account the specifics of the target company. There is always room for interpretation and it is frequently challenging to access relevant information, for instance due to long supply chains. It is also difficult to predict the future in terms of sustainability. All of these uncertainties are reflected throughout the way each particular acquisition process evolves and the outcome ultimately reached.
The varying sustainability maturity of acquisition targets creates its own challenges, notes Eklund.
“Often things are not documented that well, especially in smaller companies. On the other hand, companies may have nicely documented processes and guidelines on how things should be, but it is difficult to verify how the processes and guidelines are implemented in practice,” says Eklund.
According to Eklund, issues related to the environment and governance are often easier to cover in the due diligence, but matters relating to social responsibility may be more challenging to assess.
“For example, employee turnover and its underlying causes or the company’s attractiveness in the eyes of skilled employees may be crucial information for the valuation of the company and its value creation potential. However, it may be very challenging to obtain a true understanding of these,” notes Eklund.
Assessing sustainability issues is a team sport
Manninen and Eklund highlight that the investigation of sustainability issues is not solely the task of lawyers, but requires a wide range of experts, both internally at the client and on the advisor side. Legal issues must be made understandable also for non-lawyers.
“As a client, I would carefully consider which elements of sustainability are essential and how I could get sufficient clarity on them in cooperation with different advisors. This is a joint effort which requires varied competences,” says Eklund.
Dittmar & Indrenius will celebrate its 125th anniversary next year. The firm has had a practice group specialising in sustainability issues for several years. Currently, Dittmar & Indrenius is also the legal partner of the FIBS corporate responsibility network and provides sustainability related services in cooperation with Miltton.
“We want to share information on sustainability requirements widely through different networks and events. We believe that openness is the best way to promote sustainable development. We encourage everyone to take part in this,” says Manninen.
According to Eklund, the goal is to provide comprehensive advice.
“Within the firm, we have top experts in a broad range of areas and our firm offers a wide range of knowledge and experience. We always form the teams of experts that best meets the needs of the client,” says Eklund.
Dittmar & Indrenius is able to advise clients in sustainability issues in all of the firm’s legal service areas. The aim is to provide insightful advice which takes relevant sustainability aspects into account, even when the assignment is not directly related to sustainability matters.
Sustainability in acquisitions
Executive summary: Sustainability in M&A Transactions
Publication in Finnish: Vastuullisuus yrityskaupoissa (pdf)