
Sustainability and ESG
Sustainability or Environmental Social and Governance (ESG) must be at the heart of every organization's business model.
For the longest time, due diligence has been the foundation of informed decision-making in the fast-paced world of mergers and acquisitions (M&A). Traditionally, the components of a due diligence exercise include assessing financial performance, legal compliance, and operational efficiency to evaluate the true value of the target company and uncover aspects of the company that may pose significant risks. However, with the growing recognition of substantial and indirect impacts that some non-financial issues can have on overall financial performance, more investors are expanding the scope of their due diligence to cover emerging issues that could pose potential risks to the long-term success of their transactions.
According to the 2024 Global Risk Report by the World Economic Forum, five (5) out of the top ten (10) risk projections for the next two years, and seven (7) out of the top ten (10) risk projections for the next ten (10) years were environmental and societal issues. Other issues like inflation, economic downturn, cyber insecurity, interstate armed conflict, misinformation and disinformation, and adverse outcomes of AI technologies were categorised under economic and technological risks and would require sound and effective governance to address. What this means is that to maximise their investments, investors must follow a more structured approach to addressing the E, S, and G issues associated with their transactions.
With global priorities shifting towards sustainability, ESG brings depth and perspective that go beyond the balance sheet. Ignoring that would mean that non-financial risks and some long-term opportunities can slip through the cracks, potentially compromising the long-term success of the investments.
This article explores how ESG revolutionizes the due diligence process, the value it offers, and why investors should consider it in their M&A strategy.
ESG - an acronym for Environmental, Social & Governance -- refers to a company’s activities concerning its impact on the natural environment, social responsibility, and governance practices. With an increase in regulatory pressures regarding greenhouse gas emissions, supply chains, labour, employee welfare, sustainability reporting, etc., it has become essential for investors to prioritize ESG considerations in their transactions. From predicting imminent regulatory risks, to unveiling hidden environmental-related liabilities and assessing the cultural fit of a potential acquisition with strategic goals, ESG considerations help to elucidate the true value of a target company.
From “E” to “E&S”, and now “E-S-G”, the consideration of non-financial issues in making strategic business decisions has been in existence since as far back as the 1930s. Specifically for M&As, the Amazon-Whole Foods merger in 2017 that failed owing to the hiccups experienced concerning blending both cultures proves that the traditional approach to due diligence is no longer sufficient to uncover material risks like cultural incompatibility.
From a regulatory point of view, the European Union (EU) already requires large companies and all listed companies to regularly report on their environmental and social risks. These reports must include details of how their activities impact people and the environment. Earlier this year, the Financial Reporting Council of Nigeria (FRC) released a roadmap report that outlines the steps for entities in Nigeria to adopt the IFRS Sustainability Disclosure Standards with mandatory implementation starting in 2028. Institutional investors acquiring parts of or entire companies will be required to have systems in place to adequately report on ESG issues as indicated in the FRC roadmap report.
The inclusion of ESG factors into M&A due diligence would significantly influence the dynamics of transactions. Nick Anderson, a member of the International Accounting Standards Board (IASB) in 2019 opined in a paper that climate-related risks and other emerging risks are likely to have direct valuation implications which include, but are not limited to:
In the same vein, a company with a strong track record of ESG management can position itself for enhanced valuation and depending on the alignment of strategic objectives, may attract environmentally/socially inclined investors.
ESG risks like environmental liabilities, social controversies, or governance issues can lead to increased costs, reputational damage, and avoidable regulatory fines, ultimately reducing the deal's attractiveness to potential buyers. Conversely, strong ESG performance can enhance a company's valuation by signaling its long-term sustainability and resilience.
Sound ESG management on the seller’s side can influence negotiation dynamics as buyers may use ESG risks as bargaining chips to negotiate lower prices or more favourable terms. Sellers who prioritize their ESG credentials may have greater negotiating power and be able to command higher valuations.
ESG-related issues left unattended can significantly impact post-acquisition integration. An example is the failure to address environmental degradation or community unrest which may result in disruptions in operations, bad media representation, and unnecessary litigation, thereby stalling the successful integration of the acquired company.
While ESG in due diligence helps mitigate risks, it also presents significant opportunities for value creation.
With more investors profiling companies with poor ESG performance as high risk, the requirements are becoming increasingly stringent. As stated earlier, many EU member states have incorporated the Corporate Sustainability Reporting Directive (CSRD) into national laws, with the first companies required to report under this regulation by 2025, covering information for the 2024 financial year. The CSRD requires disclosures that cover a wide spectrum of environmental, social, and governance topics.
By January 2028, the International Sustainability Standards Board (ISSB) Sustainability and Climate-related disclosure standards would become mandatory for all public interest entities (PIEs) in Nigeria. The Financial Reporting Council of Nigeria (FRC) is the regulatory agency to ensure compliance with the ISSB.
Companies would be required to provide insights into their ESG impacts, risks, and opportunities, including their strategy, targets, progress, products, and services. As the business landscape continues to evolve, newer regulations will emerge to ensure the sustainability of the marketplace.
Conclusion
Whether you are a seller aiming to maximize value or a buyer looking to minimize risks, ESG as a framework would bring more depth and perspective to due diligence enabling the strategic positioning of your next deal. ESG-related risks can transform into opportunities that boost your capacity for value creation – for you, your stakeholders, and wider society. From ESG strategy & transformation to reporting and assurance, Forvis Mazars remains committed to supporting you at every stage of your sustainability journey.
Explore how ESG considerations can enhance your M&A strategy. Discover the tailored solutions we offer to mitigate risks, unlock opportunities, and drive long-term growth.
This website uses cookies.
Some of these cookies are necessary, while others help us analyse our traffic, serve advertising and deliver customised experiences for you.
For more information on the cookies we use, please refer to our Privacy Policy.
This website cannot function properly without these cookies.
Analytical cookies help us enhance our website by collecting information on its usage.
We use marketing cookies to increase the relevancy of our advertising campaigns.