Skip to main content
#Corporate Finance #Mergers & Acquisitions

How an increasing focus on ESG impacts M&A

Friday 18/03/2022
Het effect van de groeiende aandacht voor ESG op fusies en overnames

Whether you sell or buy a company, at some point you will have to bring ESG into the equation. Environmental, Social and Governance issues increasingly affect deals, so investors and financial institutions have to pay more and more attention to them.

Christoph Schlotthauer, Managing Partner COFFRA and a member of Moore Global Corporate Finance, explains why and how ESG is no longer a soft topic, but defines the quality or the valuation of a deal. It may even turn out to be a dealbreaker.

Chicken and egg

Why ESG is high on the agenda and why it will affect M&A thoroughly, is in fact a chicken and egg situation.

On the one hand there’s a big push from the legal and regulatory side. Worldwide the ESG trend is set to accelerate in the wake of the COP26 climate summit (held in Glasgow in November 2021). In Europe, tough new regulation and directives to meet strict targets are to be introduced shortly (in the EU Corporate Sustainability Reporting Directive, or CSRD). The CSRD will require 50,000 firms to provide a non-financial statement on a series of ESG-related factors. These requirements are expected to be applicable from 2024.

In the US the stock exchange is trying to impose norms and regulations. In short: ESG is conversing business – and thus Corporate Finance – on a global scale, bringing new standards and laws that will definitely oblige firms to comply. Translated to M&A: deals which are more compliant will be easier, quicker and more valuable.

On the other hand, we see a rapidly growing conscience that although shareholders return is key, there’s a broader responsibility to society as a whole. Fact is that consumers and employees increasingly check out the value of products and the suppliers a company is working with. From this perspective, the regulatory tightening can be interpreted as a reaction on a broader shift in society which is forcing legislators to come up with the framework to deal with these challenges.

Whatever the cause (the chicken or the egg), the results are the same:

  • deals will reflect companies’ desires to boost their ESG credentials and offload businesses which make them uncomfortable
  • ESG driven corporations will be seen as more successful on the long term. This makes them more attractive and more valuable in a dynamic M&A
  • investors will increasingly look for targets which are ESG compliant

ESG versus greenwashing

Since ESG has more and more impact on M&A deals and valuations, the challenge to differentiate between greenwashing and meaningful purpose drivenenterprises and perform truthful due diligences – which go beyond ‘simply’ applying laws – will be tough. A job for experts only.

In the recent past due diligence would determine whether a company is compliant with paying taxes, with social regulation, etc. Nowadays, an environmental due diligence has also become state of the art in certain industries. What is new, however, is due diligence with a full focus on ESG: are environmental, social and governance issues embedded in the way the company is managed? Is there a strategy to discontinue certain products or questionable suppliers?

The questions ‘do you have values?’, ‘how do you live up to them?’, ‘how do you control them?’, ‘how do you report on them?’, which should be part of any ESG due diligence, are also quite new from the investor’s perspective.

To qualify if a company is compliant is easy on some aspects (decarbonization) but tougher on others (gender or racial equality, social issues). What makes it even more difficult to come up with a red flag report, is that ESG targets are not fixed: the market, the framework, the regulation… is not yet mature. The industry, and Corporate Finance, has to find the right position.

But the evolution is swift: in a survey conducted by one of the big four in France over the priorities of CFOs for 2022, 90% of the respondents say they believe that over the next five years the quality of ESG reporting will have the same quality and auditability as ‘pure’ financial indicators.

An attractive dealbreaker

ESG can be a dealbreaker on multiple levels. ESG can be a dealbreaker because the target is not compliant and the buyer doesn’t see a way to make a turn-around and integrate it in a broader ESG strategy. It can be a dealbreaker because you uncover certain risks (see: the importance of ESG due diligence). Over 4 out of 10 respondents in a survey conducted by Datasite expect environmental concerns to be the biggest dealbreaker in 2022.

More and more banks are inclined to grant a loan exclusively to ESG compliant projects. Or if they do otherwise, they charge higher rates. This is not surprising, because banks are also rated by their ESG portfolio and behavior.

The upside: the market loves ESG compliant companies. Investing in environment, social and governance issues equals attracting good staff members and loyal customers.

There are also financial rewards:

  • McKinsey calculated that within a panel of more than 1,500 ESG studies, 70% showed a positive impact of ESG scores on financial performance and reduced cost of capital by up to 10%.
  • As investors’ money pours into assets, average EBITDA-multiples in renewable asset deals rose from 13.1 in 2018 to 15.2 in 2021. Measured by sales, multiples soared from 5.4 to 14.1 over the same timeframe.
  • Investors reassign billions of dollars using ESG criteria. Thomson Reuters data show that ESG deals skyrocketed from $92 billion in the whole of 2020 to $103 billion in only the first half of 2021.

A study of McKinsey explains: “Executives and investment professionals today largely recognize that ESG issues can affect company performance, and the financial impact of ESG programs is likely to increase as expectations and scrutiny from investors, consumers, employees, and other stakeholders continue to grow. Willingness to pay a premium for companies with strong ESG performance and the belief that ESG performance is associated with overall management quality suggest that more investors and executives will incorporate ESG into their financial and strategic decisions.”

Contact one of our experts

Philippe Craninx

Philippe Craninx

Managing Partner Corporate Finance

Contact