M&A Due Diligence process must undergo a transformation.

ESG considerations are paving the way for better dealmaking decisions

Integrating ESG into M&A due diligence is no longer optional. The rise in regulation alongside the pressure from stakeholders has meant that acquirers should push for increased transparency to avoid overpaying for targets. Environmental damage and unethical labour have led to an increase in scrutiny not only of companies but of their whole supply chain. Here we review the impact of ESG and how to approach due diligence.

ESG is vast hence focusing on what’s essential is key. The common denominator across sectors is the response (or lack of) of a company on potential financial impacts to the company caused by climate change as well as the impacts of the company on the same. Acquiring a company means acquiring the future costs of the company’s GHG emissions. Another denominator is resources and that is scarcity of resources. Will the company be able to operate in an environment of stressed natural resources? Can their great rate of return on investment be sustained? Or in case of a lagging company, is there is potential to augment the company’s capabilities to create value? These considerations should be factored into the acquirer’s model.

Research shows that while acquirers and investors conduct due diligence on ESG issues at investment and M&A targets, most investors do not consider ESG factors in the valuation of the target. (Source: Baker Tilley International, 2021) One of the reasons behind this oversight is their lack of clarity on the dollar value of future risk and impact. However, ESG is now mature enough and there is sufficient guidance and tools on how to account for risk and impact (e.g., climate physical or transition risk). The other argument put forward is the short time horizon of M&A models versus the long-term horizon of ESG risks. Legislation is constantly evolving and so are climate and emerging solutions. In this context,
ESG will also affect the 5 to 10-year horizon of exit strategies.

How should an acquirer approach due diligence?
First, taking a materiality driven approach, i.e., looking at the key materiality issues for the target’s sector of activity is essential. Some companies or Private Equity funds also integrate their own cross cutting indicators in every transaction such as diversity and inclusion, data security and privacy or climate change considerations. Value creation opportunities can also be found analysing indicators such as employee retention and responsible products or
services. Second, modelling scenarios to reflect how different factors could affect an exit strategy can help the acquirer decide on the scale of opportunities or risks. Finally, ensuring the investment is aligned with the acquirer’s own decarbonisation trajectory and sustainability strategy will contribute to unlocking value.

ESG is an essential to embed throughout the deal cycle, from the due diligence phase throughout the investment or merger period. While searching for alpha, investors and acquirers have a huge role to play in helping targets become more sustainable.


(2021). ESG more critical than ever in M&A. Baker Tilly International.