How Important is ESG in M&A Transactions?

Environmental, Social and Governance (ESG) is attracting increasing attention from investors and acquirers when evaluating investment, growth funding and M&A opportunities.   

At the outset of a possible deal, investors and acquirers are now taking more rigorous ESG considerations into account.  They are seeking alignment with their own ESG policies – therefore understanding and assessing a target’s ESG position can be crucial to them, right from inception.   

Driven by funder expectations

Some investors and acquirers will be driven by ESG expectations from their funders on where their capital is being deployed.  Many of these, for example will be institutional investors, pension funds and family offices, and their criteria then flows down into growing rigor in investment conditions and performance monitoring requirements.   

Private equity company investors are leading the way here.  This is partly attributed to their funder expectations, but it is also being driven by increasing regulation.   

Increasing regulation can be an unexpected surprise

It may be a surprise to many private equity or growth fund backed businesses in the UK that they may be subject to an important EU regulation for ESG.  SFDR (Sustainable Finance Disclosure Regulation) is an EU regulation is designed to provide compulsory ESG disclosure obligations and transparency towards sustainability.  The reason why this could apply to some UK businesses is because if their backer raises any funds in the EU (most of the big ones do) then they may be obliged to report on SFDR.  

SFDR is only one of many regulations that businesses will need to be aware of.  The list is large and potentially confusing, so understanding what is necessary and applicable is important.  A company’s jurisdiction and where it operates is also key.  For example, with its cross-border trade arrangement with the Republic of Ireland, businesses in Northern Ireland might need to consider how competitive they are compared to those with stricter EU ESG reporting requirements, which may make them more appealing for investment.    

Meeting sustainability reporting requirements

Other key regulation criterion includes the size of business; a measure of revenue, staff numbers and energy consumption.  For small to medium sized businesses, it may appear that many regulations will not apply to them.  Whilst this might be the case for some today, it is widely understood and agreed that with government aspirations to meet climate change and net-zero targets, international community pressure, and growing investor sentiment, that regulation hurdles and benchmarks are moving down to include smaller businesses.  In addition to this, through assessing their indirect emissions, suppliers are also demanding increased reporting and higher ESG credentials. 

The health and profile of a company’s ESG position is therefore an important factor to consider for any business looking to commence any M&A, growth funding or investment opportunities.  Whilst ESG may require some initial expenditure to businesses, the recognition of the benefits is numerous and omnipresent, and these will help deliver new growth, competitive advantage and value. 

Where to start

A good place to start is to understand what factors and issues are material to a business and their stakeholders within the categories of environmental, social and governance.  Every business and their sector will be different, depending on what it does.  An office based professional services business will face different ESG challenges to a manufacturing company.  Policies such as modern slavery, GDPR and cyber security may be material to the former for example, whereas energy consumption, water use and the source of raw materials may be more material to the latter. 

Establishing an open and honest ESG profile that recognises the current sustainability status of a business is not as daunting as it might sound. Companies should consider setting an ESG strategy for sustainable transformation informed by its material issues. They should set realistic and achievable performance improvement targets and demonstrate a commitment to delivering these. 

Key, thereafter, is communicating this clearly, effectively, and genuinely to all stakeholders; these will range from investors and clients to team members, new recruits, and potential clients, as well as banks, funders, insurers and more.     

If you have any questions or you need support with ESG please do not hesitate to contact Alasdair Green, Head of ESG for AAB Group.