MHA | Is ESG starting to become relevant to M&A transaction processes?

Is ESG starting to become relevant to M&A transaction processes?

Andrew Feeke · May 2nd 2023 · read

Laptop green office space

Whilst not a new concept, environmental, social and governance (“ESG”) considerations have become increasingly prevalent for UK businesses over recent years. Legislative changes leading to large corporates self-reporting on their ESG performance have helped drive the relevance of ESG in the corporate environment. 

With the trickle-down effects leading to many companies now recognising the need to develop an ESG strategy to stay relevant and competitive in the ever-changing corporate environment, the phrase “ESG” is being heard more and more within the workplace.

In the past, M&A transactions primarily focused on financial and legal due diligence. However, in recent years, ESG considerations have become increasingly important in the M&A process due to their impact on financial performance, reputation, and regulatory compliance. When an acquiror is undertaking their due diligence on the target company, alongside potentially raising new debt or equity to fund the transaction, the ESG performance of the target company is coming under increased scrutiny.

ESG factors such as environmental impact, labour standards, human rights and corruption can significantly affect a company’s attractiveness. Companies with strong ESG practices tend to have lower operational costs, higher employee productivity, and stronger brand loyalty. These factors can result in a higher valuation of the company, making it more attractive to potential buyers not only through improved financial performance, but also the strong overall governance structure implying a reduced risk profile when considering the potential for post completion issues.

Anecdotally, we’ve seen for the first time over the last six months some of the most active private equity investors appointing external ESG due diligence providers. The investors will not simply be using the findings to mitigate any ESG risks prior to committing to their investments, but are also likely to have one eye on an exit and ESG value creation opportunities that the target company can implement post-investment.

If private equity investors identify the impact ESG can have on ultimate deal value, so should all current business owners contemplating a sale in the short-medium term.

Further, we’ve seen first-hand high-street banks who have turned down new lending opportunities, not because of affordability concerns or issues with covenant testing ratios, but instead because the proposed corporate borrower did not align with the bank’s own ESG values. Such an example demonstrates that lenders are not simply viewing ESG as a ‘tick-box’ exercise and are going to stand by their own ESG policies when it comes to lending criteria. We anticipate examples such as this will only become more commonplace.

As a display of how serious we view the subject matter as a firm, we are committed to working toward achieving B Corp status, which will mean our own ESG commitments are audited and certified by a world-leading independent organisation.

Time will tell how the importance of ESG in the context of M&A transactions will evolve moving forwards. However, if the trajectory we have seen over recent months continues, having an ESG policy which stands up to the test of external scrutiny is likely to become a further pre-sale consideration for business owners.