ESG factors must play a far bigger role in M&A deal due diligence, says Accuracy

Analysis of a business’s Environmental, Social and Governance credentials must play a far bigger role in due diligence for M&A deals, says Accuracy, a global independent financial and strategic consulting firm.

Accuracy says that businesses are becoming increasingly aware of how underperformance on ESG metrics can increase risks and affect the long-term returns of companies they acquire. The firm says that ESG analysis must now be treated as an integrated part of the due diligence process, rather than as an ‘add-on’ as is still frequently the case.

The firm says that an important role played by due diligence is to broaden the perspective of the deal making process. Besides the more typical due diligence investigations like financial, legal and tax, a better understanding of ESG factors like market circumstances, competition and the supply chain is now also increasingly seen as vital in that process.

ESG analyses includes benchmarking of ESG performance against peers, and recommendations on how valuations should change due to an ESG risk or opportunity being identified. The firm explains that depending on the industry of the target business in an M&A deal, there can be a very broad range of ESG factors for businesses to analyse as part of their due diligence processes. These could include:

Environmental: e.g. carbon emissions, sustainability of resource use, management of waste
Social: e.g. supply chain risks, product safety and quality, labour practices, diversity & inclusion
Governance: fraud and corruption, fair trade, business ethics and governance & transparency
Accuracy says that the integrated approach and the maturing field of ESG analysis can quickly uncover issues in relation to these areas that that are ‘deal-breakers’.

Robert-Jan Drenth, Manager at Accuracy, comments: “ESG analysis has previously been a “tick the box” exercise – simply identify existing risks like missing environmental permits - rather than trying to assess how emerging trends in ESG will affect earnings in the future.”

“Identifying ESG risks now can prevent a business acquiring problems that will be costly to rectify in the future and can damage their brand significantly. In a constantly-changing regulatory environment, no business should assume that an emerging ESG risk today cannot become a substantial cost tomorrow.”

Accuracy says that businesses investigating the ESG risks of a potential acquisition must take a broad approach to how they undertake due diligence. As well as undertaking desk research to understand all the potential risks within a particular business and examining its historical financials, they must ensure they must speak to a range of different experts on the sector or geography, including sector economists, academics at business schools and industry analysts.

Drenth says: “For anyone who is not embedded in a business, it can be very challenging to understand the real ESG risks it faces. There are lots of other avenues for a business to explore to get a more detailed picture of the risks. Speaking to industry experts can give you a more accurate understanding of how a business treats its workers and a better grasp on its governance.”

Accuracy adds that when benchmarking a potential acquisition against its peers, attention should be paid to the areas in which it outperforms its ESG benchmarks to assess the potential value that good ESG performance could add to the business in the longer term. The firm says that investments in ‘doing good’ – besides risk mitigation – often create value, such as through increased market share or operational benefits in terms of costs reduction from increased production efficiency.

With ESG performance becoming an ever more important consideration in purchasing decisions for both individuals and businesses, those looking to make acquisitions should look to assess whether a business that is a ‘good actor’ across the ESG spectrum could in future benefit from faster growth or reduced costs. This could factor into decision-making over the price of an acquisition or the exit potential.

Drenth says: “The next stage in the development of ESG due diligence is seeing it not as a process of eliminating negatives, but also of finding and highlighting positive opportunities. As ESG continues to factor into more and more corporate and consumer decision-making, the value of being an ESG leader will grow. That can make it valuable to seek out businesses that are ahead of the curve.”