ESG Due Diligence: Assessing Sustainability in M&A

In today's business landscape, sustainability and responsible business practices have become increasingly important considerations for companies and investors alike.

Environmental, Social, and Governance (ESG) factors are now recognized as critical indicators of a company's long-term viability and resilience. As a result, ESG due diligence has emerged as a crucial component of mergers and acquisitions (M&A) processes. This blog post will explore the concept of ESG due diligence in M&A, its benefits, challenges, and the factors that determine its outcomes.

What is ESG Due Diligence in M&A?

ESG due diligence in M&A refers to the process of assessing the environmental, social, and governance risks and opportunities associated with a target company before completing a merger or acquisition. It involves evaluating the target company's sustainability performance, policies, and practices to determine its alignment with the acquirer's ESG goals and objectives. ESG due diligence helps identify potential risks and opportunities that could impact the financial performance and reputation of the acquiring company.

Benefits of Incorporating ESG Considerations into M&A

1. Enhanced risk management: By conducting ESG due diligence, acquirers gain a deeper understanding of the target company's exposure to ESG-related risks. This enables them to better assess potential financial liabilities and reputational risks associated with ESG issues, such as climate change, human rights violations, or governance failures. By identifying and addressing these risks early on, acquirers can mitigate potential negative impacts on the value of the transaction and the long-term success of the merged entity.
2. Improved long-term performance: Companies with strong ESG performance have been shown to outperform their peers in terms of financial returns and resilience. By incorporating ESG considerations into the M&A process, acquirers can identify companies with robust ESG practices and leverage their sustainable business models for long-term value creation. This can lead to improved operational efficiency, customer loyalty, and access to new markets and opportunities.
3. Reputation and brand enhancement: ESG issues, such as climate change, social inequality, or corporate governance scandals, can significantly impact a company's reputation and brand value. By conducting ESG due diligence, acquirers can identify any potential reputational risks associated with the target company's ESG performance. This enables them to make informed decisions about whether to proceed with the transaction and take appropriate measures to address any identified risks, thereby safeguarding their own reputation and brand value.
4. Stakeholder engagement and trust: In today's interconnected world, stakeholders, including investors, employees, customers, and communities, are increasingly demanding transparency and accountability from companies. By incorporating ESG considerations into the M&A process, acquirers demonstrate their commitment to responsible business practices and stakeholder engagement. This helps build trust with various stakeholders and can lead to enhanced relationships, market access, and financial support.

Challenges of ESG Due Diligence in M&A

1. Lack of standardized metrics and reporting: One of the main challenges of ESG due diligence in M&A is the lack of standardized metrics and reporting frameworks. This makes it difficult for acquirers to compare and evaluate the ESG performance of different target companies. To address this challenge, various organizations, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), have developed frameworks and guidelines to help companies report on their ESG performance. Acquirers can refer to these frameworks to guide their ESG due diligence efforts.
2. Limited availability and reliability of data: Another challenge of ESG due diligence is the limited availability and reliability of ESG data. Many companies do not disclose comprehensive ESG information, making it challenging for acquirers to assess their ESG performance accurately. To overcome this challenge, acquirers can leverage third-party ESG data providers, industry benchmarks, and engage in direct dialogue with the target company to gather relevant information.
3. Integration into existing due diligence processes: Incorporating ESG due diligence into existing M&A due diligence processes can be challenging, especially if acquirers do not have established ESG frameworks or expertise. To address this challenge, acquirers can seek external expertise from sustainability consultants or consider building internal capabilities to effectively assess and integrate ESG considerations into their M&A processes.

Factors that Determine Outcomes of ESG Due Diligence

The outcomes of ESG due diligence in M&A are influenced by several factors:

1. Leadership commitment: The commitment and support of senior leadership are crucial for the successful integration of ESG due diligence into M&A processes. When leaders prioritize ESG considerations and set clear expectations, it signals the importance of sustainability and responsible business practices throughout the organization.
2. Alignment with strategic goals: The extent to which ESG considerations are aligned with the acquirer's strategic goals and objectives can influence the outcomes of ESG due diligence. When ESG considerations are integrated into the broader strategic rationale for the transaction, it increases the likelihood of successful integration and value creation.
3. Robust due diligence process: The thoroughness and rigor of the due diligence process can significantly impact the outcomes of ESG due diligence. Acquirers should ensure that their due diligence process includes a comprehensive assessment of ESG risks and opportunities, involving relevant stakeholders and utilizing appropriate tools and frameworks.
4. Post-merger integration: The successful integration of ESG considerations into post-merger integration processes is critical for realizing the potential benefits of ESG due diligence. Acquirers should develop a clear integration plan that includes specific ESG targets and milestones and ensures ongoing monitoring and reporting of ESG performance.

Merck & Co.'s ESG Due Diligence in its Acquisition of Antelliq

One example of a company that has incorporated ESG due diligence into its M&A processes is Merck & Co., a global pharmaceutical company. In 2018, Merck acquired Antelliq, a leading provider of digital animal identification, traceability, and monitoring solutions. As part of the due diligence process, Merck conducted a comprehensive assessment of Antelliq's ESG performance, focusing on its environmental impact, social responsibility, and corporate governance practices.

Merck recognized the strategic value of Antelliq's technology and solutions in advancing sustainable agriculture and improving animal welfare. By integrating ESG considerations into the due diligence process, Merck was able to identify the potential risks and opportunities associated with Antelliq's ESG performance and develop a post-merger integration plan that leveraged Antelliq's ESG strengths.

Conclusion

ESG due diligence has become an essential component of M&A processes, allowing acquirers to assess the sustainability performance and potential risks and opportunities associated with target companies. By incorporating ESG considerations into the M&A process, companies can enhance risk management, improve long-term performance, enhance reputation and brand value, and engage stakeholders effectively.

However, there are challenges, including the lack of standardized metrics, limited availability of reliable data, and integration into existing due diligence processes. By considering these challenges and leveraging the factors that determine the outcomes of ESG due diligence, companies can ensure sustainable growth and long-term value creation.