14 May 2024
Environmental, social, and governance (ESG) factors are becoming increasingly important in all aspects of business, none more so than mergers and acquisitions (M&A).
Translink Corporate Finance UK Partner Kevin Davies shares insights into the prominence of ESG in dealmaking.
Kevin said: “Environmental, social, and governance considerations have evolved from being a niche concern to a fundamental element in the decision-making processes of companies, investors and regulators alike.
“ESG is having a growing influence on the M&A landscape, with social pressures proving to be the greatest driver of this adoption. Businesses that fail to adequately address issues can face reputational damage, lost customers, and increased regulatory scrutiny which inevitably impacts investment decision-making.
“For middle-market companies, ESG policies and procedures may not be as well-developed as for larger peers. However, it is no less important. It can no longer be a brief reference in a company’s financial reports; it must form a central pillar to overall business strategy.”
“Those with strong ESG policies and embedded procedures are being considered more attractive by both buyers and investors, often attracting higher valuation multiples.”
The ESG influence on investor decision-making, and M&A generally, is growing across several areas:
- Regulatory landscape – the UK government and regulatory bodies have introduced stricter ESG reporting and compliance requirements. This legal framework encourages companies to prioritise ESG-related issues. Failure to meet standards can result in legal consequences, feeding into investors’ ultimate investment decisions.
- Due diligence – with the more heavily regulated environment ESG considerations are being built into deal processes with increasing frequency. Potential acquirers and investors scrutinise target companies identifying potential financial, operational, and reputational risks that may be associated with poor ESG performance. Transactions can stall, or even collapse, on finding ‘red flag’ issues in such diligence.
- Private equity – financial investors are placing particular emphasis on their ESG pre-investment procedures driven by the requirements of their funds. There is an increasing expectation amongst the professional investment community of well-developed ESG policies and procedures being a central plank to business strategy.
- Access to capital – Companies that place a priority on ESG are often more appealing to a broader range of investors. This broader appeal can translate to easier access to capital, making fundraising and M&A transactions more feasible.
- Valuation – Whilst it can be difficult to quantify the impact of value and risks around the lack of an ESG strategy, it needs to be considered a long-term plan. Companies with strong ESG policies may command premium multiples, whilst those with poor records risk becoming less attractive targets for buyers and investors.
A company must demonstrate a strong understanding of the environmental and social issues in which it is operating, if it is unable to do this governance of risk can become challenging.
Here are some considerations for businesses of all sizes to help reduce investment risk through ESG performance:
- Data quality – evaluating ESG performance often relies on the availability of reliable data. Having processes for gathering and analysing whilst challenging will be key.
- Integration – companies need to develop and implement strategies to address ESG issues as part of their overall business strategy. Successfully integrating ESG factors into a fundraising or M&A process then becomes more straightforward, reducing deal risk.
- Balancing interests – the interests of all stakeholders must be considered, with increasing levels of activism and influence across all groups balancing financial returns with ESG objectives can be complex.
- Report on ESG performance transparently and comprehensively, setting clear targets and tracking progress.
Kevin concludes: “The impact of ESG on businesses and consequential ability to attract investment is significant and continues to grow. Companies, investors, and buyers are increasingly recognising the importance of integrating ESG considerations into their decision-making processes.
“My European colleagues drew similar conclusions as part of Translink’s ‘Megatrends’ series – ‘ESG will continue to impact target companies’ valuations and attractiveness, with ESG considerations examined in stage two of a deal. Integral to this evaluation is whether the target conforms to established regulations and possesses a sustainable ‘carbon balance’.”
“As regulations become more stringent and the investment community continues to place greater emphasis on responsible practices, ESG will remain a focal point. Companies that adapt and excel in these areas are likely to enjoy a competitive advantage in attracting prospective investors.”
To discuss ESG implications, and the impact it might have on potential buyers and investors get in touch with Translink Corporate Finance UK Partner, Kevin Davies on kdavies@translinkcf.uk.com
