How to embed ESG into your M&A deal

Impact investing has been around for a long time – people putting money into businesses doing good things. Investing in ‘doing good’ often creates value, through increased market share or operational benefits in terms of cost reduction, as well as reducing risks. Less attention has perhaps been paid to date on the role of Environmental, Social and Governance (ESG) in M&A deals, but it’s starting to gain momentum.

In a LinkedIn poll conducted recently by KPMG, 54 percent of respondents said ESG is now involved in every or most strategic deal-making decisions, with only 18 percent saying ESG wasn’t part of their key criteria. I have witnessed first-hand businesses becoming increasingly aware of ESG metrics in terms of valuation, risks and value creation opportunities. Buyers are switching on to the fact fast that a business’s future earnings will be impacted by ESG. The last two M&A integrations I have led have had ESG front and centre as opposed to what I have seen in the past, which is it’s a component part to be managed.

So how do you embed ESG into your deal-making activity and avoid it becoming a box ticking exercise? There are three areas of focus and my learnings in each.

1. Deal scan with your own ESG strategy in mind

• Start with your own ESG strategy (as part of your broader corporate strategy), examining both strengths and areas to develop so you can determine where targets may help you accelerate in certain areas. international standards, UN Sustainable Development Goals, and peers in your sector.

• Challenge your M&A team to consider targets that advance the organisation’s pursuit of ESG goals and make it a key part of your acquisition criteria.

• Take a broad view on the types of measures to look at. These may include:

o Environmental measures: eg carbon emissions, sustainability of resource use, management of waste

o Social measures: eg supply chain risks, product safety and quality, labour practices, diversity and inclusion

o Governance measures: eg fraud and corruption, fair trade, business ethics and governance and transparency

2. Make ESG an integral part of your deal due diligence

• Find targets that help improve your ESG profile in areas where you have the largest gaps to close.

• Screen targets for their ESG credentials and assign financial values to ESG factors. Price ESG factors into determining the valuation.

• Benchmark a targets ESG credentials against their closest competitor set - there is to date no standard to identify the relevant metrics to measure each and every ESG factor, but a combination of different measures can be pulled together.

• Ensure you have access to tools and data to help integrate and analyse a targets

ESG credentials and future risks and opportunities.

• Get a broader set of perspectives on targets – industry analysts, behavioural economists and academics. You may want to think about engaging multiple specialists on different aspects of ESG.

• Consider how ESG credentials impact your exit potential.

• Assess how it impacts your value proposition to customers and how to ‘bring best of both’ companies together. • Consider your sources of capital to fund deals - ESG factors are increasingly important for unlocking capital (debt and equity) and are becoming on a par with EBITDA, P&L and overall performance.

3. Make ESG a pivotal part of your integration efforts

• Consider how the overall business profile has changed and what are the most material risks and opportunities, best practices and roadblocks to manage. • Have a dedicated ESG integration workstream addressing the above areas which works closely with all workstreams, including procurement, risk management, people and culture, and leadership.

• Build ESG into your integration playbook and toolkit as an integral component.

• Ensure that the credentials you identified in due diligence are not being lost in the integration of the business through synergy delivery.

• Make ESG measures a critical component of your integration scorecard, tied to the financial objectives.

• Use it as an opportunity to improve recording and reporting against ESG criteria, and consider how this might need to change and evolve with the addition of the acquired business.

• Prioritise areas of joint ESG improvement for your corporate scorecard.

• Make ESG part of integration communications across the business – highlighting the joint benefits to employees and stakeholders and use it as an internal education opportunity.

Companies in my experience will often now be using M&A to enhance their ESG credentials, improve their supply chain, innovate their business and operating model, and create value through margin improvement or through identifying additional revenue generating opportunities. I have found that, by taking the above three steps, you make a positive move away from just looking at ESG through a risk mitigation lens to a value creation lens.