M&A and ESG: An Introduction to Ensuring Sustainable Value in the Corporate Transaction

This blog post is the first in a series co-authored with Amy Wojnarwsky, an attorney at McDonald Hopkins, a Cleveland-based business advisory and advocacy law firm. Amy is a leader in McDonald Hopkins’ Social Corporate Governance & Impact Investing practice and has a strong passion for helping entrepreneurs and businesses on ESG matters.

Environmental, social and governance (ESG) factors have become a growing focus for companies and their stakeholders. In addition to being essential to company culture and reputation, ESG matters are increasingly considered important value drivers for successful M&A transactions.

Investors are becoming more and more concerned with ESG metrics that can protect and maximize value and are considering the impact of such matters in their screening process, transaction risk mitigation, due diligence and other strategic decision-making.

According to a recent report from the US SIF Foundation, sustainable investing assets now account for $17.1 trillion — 1 of every 3 dollars of the total U.S. assets under professional management.

Even large institutional investors and asset management companies like State Street Global Advisors and BlackRock have issued statements stressing the importance of ESG issues in business practices and transactions decisions. 

M&A deals often present exciting opportunities with mutually beneficial outcomes and synergies, but the parties involved are susceptible to risks, including credit rating downgrades, consumer and reputational backlash and lackluster financial performance.

To curb some of this possible risk, potential partners may want to make sure that they are entering agreements with entities that commit to appropriate environmental practices and climate adaptation plans, operate within a humane supply chain free from violations and corruption, present an active community engagement record, and have a general reputation of regulatory compliance. 

While there are a number of factors that can influence the financial success of M&A deals, ESG compatibility can be utilized as a gauge of cultural alignment.  It is commonly held that 70-90 percent of all M&A transactions fail, and this is due in large part to inadequate due diligence and poor integration between the two parties.  As such, every opportunity to find culturally aligned partners should be explored — and ESG matters offer ample opportunities to find common ground. 

Strategic fit and financial profile drive most companies’ M&A strategy. ESG factors can be expected to increasingly influence how firms will select potential targets and business partners.  In recent years, due diligence requests have included questions to explore stakeholder engagement, previously conducted seller-side supply chain diligence, and exploration of the seller’s ESG policies, procedures, and performance against peers and sector best practices.  The results of this ESG-focused diligence can impact the purchase price: in a recent global survey of private equity general partners, 54% had reduced a bid price after ESG due diligence and one-third had increased the purchase price after such diligence.   

Those companies with strong ESG profiles can enhance their ability to deliver long-term value to stakeholders. For example, while Fiat Chrysler’s pending merger with Peugeot may have originated for any number of strategic reasons, chief among them is ESG. The merger will allow the company to avoid billions of dollars in carbon emissions fines from the European Union.

The COVID-19 pandemic and the racial justice movement of the past year have changed public perception of companies' roles in society.  A 2020 survey from Just Capital found that 92 percent of respondents believe that companies should contribute to an economy that serves all Americans. 

Limited partners (i.e., investors) are demonstrating a similar belief through how they invest their money.  Private Equity International’s LP Perspectives 2021 study shows that 88% of investors are taking a manager’s considerations of ESG factors into account when conducting due diligence, which is up from 80% a year ago.  Additionally, family offices and high net worth individual investors are also seeing a stronger shift to ESG considerations with a focus on good governance and positive social and environmental impact in relation to the power of their capital. 

Stakeholders are increasingly focused on corporate policies related to racial diversity and inclusion — specifically the hiring and promotion of Black employees. Recently, high-profile companies like Amazon, Facebook and Google have faced lawsuits for biased and discriminatory workplaces and practices. And moreover, the state of California passed legislation at the end of last year that all companies with principal offices in California must increase the diversity of their boards to include “underrepresented” members. 

When preparing for potential M&A and other business transactions, companies should evaluate their diversity policies and social issue strategies as part of due diligence. Executive board members and senior leadership should be prepared to account for ESG performance when discussing potential business transactions. 

In the second part of our series on ESG and M&A, we’ll delve into how to prepare for an ESG merger or acquisition to ensure a successful transition.