The New Normal: M&A & ESG
The consideration of ESG (Environment, Social and Governance) dimensions in the preparation and execution of business transactions is already a key factor for many companies. Entrepreneurs who sufficiently include these dimensions in their planning and strategy and set the right focus are ahead of the game - a vital question for both buyers and sellers.
Prominent investors such as BlackRock and Speedinvest have long been focusing on this and clearly target companies in their investment strategies that are able to demonstrate their ESG compliance and strategies or develop technologies that support sustainable developments. In the selection of strategic acquisitions of companies, the acquisition of compa-nies with sustainable corporate concepts plays an increasingly important role (certainly also in order to become ESG-compliant inorganically) and surveys therefore unsurprisingly confirm that environment, social and corporate governance (ESG) rank among the top 5 legal issues in corporate transactions, along with regulatory issues, data protection and cyber security, and even ahead of the issue of litigation.
With a view to the overriding development in the framework conditions for sustainable development in the areas of the environment, social affairs and corporate governance, any corporate review (in the context of corporate transactions but also in the selection of con-tractual partners) will only comply with the due diligence obligations applicable to the re-sponsible bodies if a sufficiently substantiated audit of ESG compliance or ESG potential is carried out. Liability risks are therefore also evident from this perspective.
What is often overlooked: ESG issues play a role in the entire transaction cycle. Target companies should define precise structures and content for the presentation of ESG issues as early as the first phase, i.e. when planning the transaction and preparing the data room, in order to be (and remain) an interesting target. On the side of the acquirer as well as on the side of the target company, an early focus on possible deal breakers in integration topics pays off: Can the target company be integrated into the buyer’s ESG compliance structure and support its goals, or can the target company’s ESG compliance structure be inte-grated at the buyer? The careful preparation of a potential buyer’s questionnaire to avoid ESG risks is the other side of the coin. In each case, the definition of the overall goals plays a very important role.
ESG due diligence is cross-disciplinary, touches on familiar and new due diligence aspects, and is designed to scrutinize companies not only with regard to environmental aspects but also, and in particular, with regard to social factors and corporate management and organization (governance). The aim is to identify existing and, above all, possible future reputational risiks and liability risks and – if quantifiable – the associated costs. The particular chal-lenge: Due to the ongoing development of the framework for ESG compliance, the due dili-gence review in this area is a volatile and predominantly forward-looking analysis.
The possible topics of ESG due diligence are wide-ranging. They range from (E = environment), e.g. the question of the use of renewable energies and the prevention of environmental pollution in the area of the entire value chain (what legal options exist, for example, to replace an existing supplier of operating resources in order to improve the carbon foot-print and what costs are associated with this), (S = social) compliance with diversity and discrimination prohibitions, recognized human rights principles, as well as general employee concerns, up to (G = governance) transparency, reporting, sustainable corporate governance and bonus systems geared to this, existence of whistleblowing systems, and much more.
When examining contractual relationships, it will be particularly important to determine generally whether there is sufficient flexibility to adapt, for example, to meet future legal requirements for supply chains. A look at the German Supply Chain Act, which comes into force at the beginning of 2023, provides an example of the indirect effect of regulations applicable to a participant in the value chain. German companies with Austrian suppliers, for example, will only be able to fulfill their due diligence and auditing obligations if the Austrian supplier is also involved accordingly and the supply contracts are adapted accordingly.
From the perspective of large companies and financial investors (and the financing banks involved), reporting obligations that are already currently in place play a key role, as these companies can only fulfill their own obligations if corresponding framework conditions already exist at the target companies or can be established with a correspondingly justifiable effort. Articles 8 and 9 of the Sustainable Finance Disclosure Regulation provide a bench-mark for what will generally have to be observed in order to fulfill transparency and reporting obligations.
Due to the lack of sufficient quantifiability, the results of the ESG due diligence will generally lead to a purchase price adjustment in the form of a risk premium or discount in the (internal) calculation of a buyer. This is especially true in view of the fact that liability for future developments is usually excluded in purchase agreements, which in turn directs the focus to a more in-depth ESG due diligence analysis and the resulting need for action, which usually influences the purchase price. It is also conceivable, of course, that exemptions, guarantees or purchase price adjustment mechanisms will be required in the event of future develop-ments occurring or failing to occur; in any case, the negotiations for suitable wording in the purchase agreements will not become any easier.
Already the initiation of transactions and even more the entry into a due diligence phase is often associated with considerable costs. In order to reduce the risks for transaction security and, as a rule, to improve the position of the seller before a buyer-side due diligence is carried out (or at least to be able to better assess one’s own position for upcoming negotia-tions), an ESG vendor's due diligence on the seller's side is advisable in many cases. Even small investments in one’s own ESG profile can pay off in many instances.
ESG considerations in corporate culture and transactions are thus the “new normal” with an importance that is increasing day by day. Buyers and sellers will only remain interesting market participants if they sharpen their own ESG profile. In the case of corporate transactions, this also means, due to the diversity of topics, identifying individual focal points of the due diligence review that are tailored to the industry, the customers and suppliers, and in each case with a view to the overall value creation potential.