ESG factors are increasingly being assessed and brought to account in M&A’s. In this article, we explain how ESG may impact on a seller in an M&A process and points out what you as General Counsel should consider to maximise value.
Environmental, Social, Governance (ESG) factors are increasingly being assessed and brought to account in mergers and acquisitions. ESG is becoming a value driver or determinant, particularly where those processes involve an international purchaser. With this in mind, General Counsel on the sell-side should be considering what each element of ESG means to their business, what their ESG strategy is and how this can be demonstrated. In this article, we explain how ESG impacts the M&A process and suggestions to consider to maximize value.
What is ESG?
There is an increased expectation on corporates to play a larger role in society, not just looking to maximise shareholder value. Companies are being expected to adopt principles to show how they will meet these societal needs and demonstrate that such principles are embedded as part of their corporate strategy – this is at the heart of an effective ESG strategy.
How does this impact M&A?
Increasingly we are seeing buyers look to an ESG strategy as an important factor when assessing risk, and pricing that risk, in their potential investment. They may have their own ESG strategy which will influence how they assess the value of an opportunity and how they assess the ‘fit’ of the target company. In particular, we are seeing a number of investment funds that have incorporated ESG considerations as part of their investment mandate and criteria. In our experience, where a company has an ESG strategy purchasers have placed premiums on such businesses and their potential returns.
Pre-transaction – consideration, and adoption
If you want to use an ESG strategy as a value differentiator, General Counsel should adopt a strategy early and put in place measures to ensure that you can demonstrate how your strategy is embedded and measured. Experience suggests that those businesses who are early adopters will extract the most value, as they will be able to demonstrate a track record of how they have implemented the strategy. Such a strategy should ‘fit’ your organization, while taking into account competitors’ and sector activities, your disclosure obligations, and risk exposure. Furthermore, you should be able to demonstrate positive outcomes from your ESG strategy and understand the cost, risk, and opportunity of your current ESG state compared to the desired future state.
Where you have identified a potential purchaser(s), you should review the purchaser’s ESG strategies (if any) and consider how your business might align with the potential purchaser’s ESG and other strategies – and use that as an opportunity to demonstrate the cultural ‘fit’ that the transaction will create.
Due diligence
While traditional due diligence can highlight areas such as health and safety and environmental risk, we are seeing more targeted questions relating to ESG strategies. To assist with this process, you should have clear documentation setting out the ESG policies you have adopted and be able to demonstrate how these policies are communicated and woven into operations and understood by the internal and external stakeholders. Our observation is that where you as a General Counsel have clear documentation, this will help your discussions with a purchaser and increase deal certainty and value.
Sale and purchase agreement (SPA)
To deal with ESG risk, we are seeing an increase in the number of specific mechanisms being included in the SPA. These have included; inclusion of specific indemnities to cover perceived and actual risks and costs, requiring the seller to take certain actions before completion, and requiring the company to take certain actions after completion or even allowing for termination of the transaction prior to completion.
Alignment of ESG principles
Once the transaction has been completed, we are seeing purchasers requiring alignment of ESG strategies. If a seller is required to stay on in the business and/or the SPA contains an earn-out clause, you may want to consider if the business will have the resources to align ESG strategies, if this will create extra work for you as seller and if you will be appropriately remunerated for this. You may also want to consider if the earn-out contemplates who will pay for the alignment or implementation of ESG strategies and how alignment or implementation of ESG strategies will be accounted for. Lastly, you may want to consider what impact the new ESG principles will have on the earn-out and/or should the cost of effecting these be excluded from the calculation of the earn-out.
For further reading on ESG, our global team has produced a full report (available here) on what boards, directors, and General Counsel need to know about ESG, as well as providing a Global Solutions Hub where additional resources can be found. Feel free to reach out directly to the authors.