By Merlin Piscitelli, Datasite EMEA Chief Revenue Officer
Environmental, social and governance (ESG) factors are now a central consideration on corporate agendas and in the M&A world. In fact, research shows that ESG is a top priority in M&A, with environmental factors registering as the highest priority.
Yet is it truly a make or break factor in M&A? The short answer is, not always. Stil, it can be a major challenge to a deal’s successful closure if not properly addressed or considered at the very start of a transaction.
With such growing importance, how can dealmakers tackle ESG concerns from the outset and deliver M&A success?
ESG becomes the first hurdle for deals
ESG has always been a factor in M&A, but has more recently taken centre stage when regulatory bodies around the world tightened requirements on disclosures, causing companies to adopt more rigorous sustainability practices. Investors, too, demanded more accountability and evidence of long-term value creation over shorter term financial performance. Additionally, consumer sentiment changed, with a strong preference for companies that demonstrate genuine commitment to ethical conduct and environmental policies.
These contextual trends have had an impact on M&A, and, post-pandemic, the ESG buzz is back. Shareholders and pension funders, often the money behind private equity, are driving this renewed emphasis because of strict ESG related bylaws and mandates. As a result, ESG considerations are now a phase one priority of due diligence. If a company cannot demonstrate a solid understanding of its ESG risks and their impact on the business, the deal will sink. For example, nearly 70% of global dealmakers surveyed by Datasite said they expected to see more deals fall apart in the future because of climate-change related due diligence risks and 89% said the increasing physical risks from climate change are influencing M&A strategies. Additionally, the research shows that 53% of global dealmakers say their company is preparing for activist board intervention related to climate change.
Organizations also need to pay attention to changing regulations and compliance. Governments in the US, Europe and the UK have called for sweeping and mandatory climate disclosures of material risks posed by climate change to a company’s business operations and financial statements. There are also new regulations in Europe on the role companies must play in addressing human rights violations and environmental risks, including in their supply chains.
Getting ESG due diligence right
Given this importance, it’s critical to get ESG due diligence right. In addition to increased regulatory scrutiny, ESG concerns are adding to the amount of content in Datasite’s virtual data rooms. Since the start of the year, content in Datasite data rooms is up by over 50%, on average, per deal.This means due diligence times can take longer. Activity on Datasite, which annually facilitates close to 15,000 deals, shows that diligence times have increased by a median of 24 days since 2021.
To ensure a smooth and efficient due diligence phase, following are some key tools to help dealmakers be successful:
- Use an ESG checklist – Dealmakers and advisers should routinely add deal-specific ESG risks to due diligence checklists. Being able to fully understand how social activities impact specific industries and target companies (and their valuations) helps ensure a smoother, more comprehensive diligence process and fewer surprises for everyone involved. Checklists make sure nothing is overlooked.
- Evaluate climate-related processes and controls and disclosure requirements – Dealmakers should evaluate material effects of transition risks and material litigation risks related to climate change. Management’s discussion and analysis should also include financial condition and results of operations in the following areas: legislation, capital expenditures, material regulation, physical effects on operations, compliance costs, and carbon credits or offsets.
- Use technology- Advanced tools and technology within virtual data rooms (VDRs) can be a huge help. For instance, some VDRs have the functionality to identify key ESG-related documents and information, through robust optical character recognition (OCR) search tools. And with search alerts, dealmakers need to search only once for a term and track when any new documents with that term are added. This way, no ESG-related documents or assets can be missed, and dealmakers can be assured that they have all the information they need to get a clear view of potential warning signs that could sink a deal. Leaning on tools such as these can simplify the process, and support dealmakers with efficiently getting a deal over the line.
ESG in M&A is only set to increase. Success will hinge on companies’ abilities to effectively integrate ESG factors into every stage of the M&A lifecycle, but particularly the due diligence stage. By adopting a proactive and comprehensive approach to ESG, dealmakers can navigate challenges, seize opportunities and drive successful M&A outcomes.
