This is how you manage ESG data during an acquisition
• The biggest ESG challenge according to M&A and private equity professionals is: ‘data collection and quality: obtaining reliable, relevant and comparable ESG data’, according to the M&A Trend Survey 2024 by M&A and Ansarada.
• ESG experts advise dealmakers not to look at ESG as an obligation, but as an opportunity. To obtain the right data to respond to those ESG opportunities, they recommend using a 360-degree approach to due diligence.
The fact that ESG factors will become much more important in the M&A process in the near future is evident from the latest edition of the annual trend survey by the M&A Community and Ansarada. However, reliable data on environmental performance, social impact and governance practices are not always available. How to adjust a sleeve there?
The impact of climate change on investment decisions
There is little doubt that ESG factors will become (much) more important in the M&A process in the coming year, according to 92 percent of the 247 participants in the latest edition of the M&A and Ansarada survey. So important, in fact, that deals sometimes don’t even go ahead due to ESG factors, according to 75 percent of respondents.
“Understandable,” says Micha van den Boogerd, Director Transaction and Responsible Investment Services of consultancy and engineering firm TAUW. “For example, climate change is already influencing investment decisions and will have an even greater impact in the future. For example, it is no longer self-evident to make strategic investments in the west of the Netherlands as long as the area is vulnerable to flooding. And when a party invests, it increasingly only does so after thorough ESG due diligence. Given all the risks that will then be exposed, a deal will indeed be more difficult to go through.”
On the other hand, climate and other ESG risks also offer opportunities, says Van den Boogerd. Particularly in the manufacturing industry, many companies are reluctant to make enormous investments to make their business operations more sustainable. Private equity firms and other wealthy parties can respond to this and make money available for sustainability measures. At least if they think it’s worth it. Because what if it doesn’t look like an investment will pay off? Or that a company continues to run major reputational risks despite sustainability measures? A deal may then fail, whether or not after attempts by the potential buyer to bring the price down.
The biggest challenge for the integration of ESG aspects
The biggest challenge in integrating ESG aspects into M&A transactions appears to be ‘data collection and quality’: ‘obtaining reliable, relevant and comparable ESG data’, according to 34 percent of respondents.
The four greatest ESG-challenges
– Data collection and quality: obtaining reliable, relevant and comparable ESG data – 34%
– Integration into valuation models: Impact on long-term value creation is often not directly measurable or predictable 28%
– Cultural and organizational integration: Integrating ESG aspects may require changes in corporate culture,
processes and systems, which can lead to resistance or complexity during the integration phase – 21%
– Complexity of ESG factors: comparing different dimensions across different companies and sectors – 17%
In the words of Bas Mees, Partner law firm Rutgers & Posch. “Collecting ESG data can be complex. It includes both quantitative and qualitative aspects, such as carbon emissions and other forms of environmental impact, workforce diversity and governance structure. While providing accurate and reliable information on environmental performance, social impact and governance practices and its measurability are essential.”
“For example, for the remuneration structure: companies want to adapt it to their ESG impact. New remuneration elements are emerging, such as ‘impact carry’, where the amount of the reward (the carried interest) for fund managers depends on the ESG impact. This only works when the impact is specifically and objectively described and measurable at fund level, but also at the level of individual participations. For this reason, it is becoming increasingly important for startups, small- and mid-sized companies to work on concrete, measurable ESG objectives and reporting on them,” says Mees.
Bas Mees, Rutgers & Posch: “New reward elements are emerging, such as ‘impact carry’. This only works when the impact is specifically and objectively described and measurable at fund level.”
Approach ESG as an opportunity to create value
But how do you, as a company or investor, get access to the right data, if that is even possible? “Focus above all on the ESG factors that are important to you,” Van den Boogerd advises. “For example, a company that only wants to comply with its reporting obligations has a very different, more limited information need than an investor that views ESG as a possible ‘value driver’, or focuses on impact.” ESG is a catch-all concept, as Van den Boogerd says. The important thing is to know what you need from that container.
Micha van den Boogerd, TAUW: “A company that only wants to comply with its reporting obligations, for example, has a very different, more limited information need than an investor who views ESG as a possible ‘value driver’.”
Leonie Schreve, partner at PwC’s Deals practice, focused on ESG, especially recommends ‘not looking at sustainability because it is or will become mandatory, but as a must to run your business even better’. She therefore argues against a compliance approach with reports that are little more than a mandatory ‘ticking the box exercise’, and advises companies and investors to view developments in the ESG field as an opportunity to create value. In line with Van den Boogerd’s argument, she points out that ESG offers opportunities to distinguish yourself from competitors, open new markets and make it easier to attract financing. And therefore to improve their financial health and increase their future sustainability.
To obtain the right data to respond to those ESG opportunities, she recommends taking a 360-degree approach to due diligence, and looking at a company from both an external and internal perspective. “External means: taking into account factors such as the sector in which it operates and the expectations of major customers. Internally means that you look at the processes and maturity of ESG initiatives within the company.”
Based on a 360-degree analysis, the possibilities can then be mapped out to both become more sustainable and improve financial performance. It will gradually become clear which data must be brought together and how it relates to financial due diligence, commercial and operational due diligence and tax. In this way, ESG can be fully integrated into the investment decision.
CSRD provides guidance
Regardless of their precise information needs, parties will often encounter the problem that the data they are looking for is not immediately available. Especially when it concerns small companies, especially as long as they are not yet obliged to report under the European CSRD guidelines. This is often a temporary problem that will disappear in a few years – when there is much more clarity about which data companies must include in their ESG reporting.
Schreve: “CSRD is rightly regarded as the IFRS (International Financial Reporting Standards) of ESG, in the sense that it offers companies many opportunities to manage better and run their business more effectively. Also smaller companies.” If these smaller companies operate in the ecosystem of large customers (who must report on the ESG policy of their suppliers) or investors, then CSRD will still be partly implemented, but that also offers them opportunities to respond to the opportunities that sustainability offers.
Leonie Schreve, PwC: “CSRD is rightly regarded as the IFRS (International Financial Reporting Standards) of ESG, in the sense that it offers companies many opportunities to manage better and run their business more effectively.”
And if companies do not yet report according to the CSRD guidelines? Mees advises investors and companies to, where possible, adhere to benchmarks and best practices of certain international initiatives and organizations such as PRI (Principles for Responsible Investment) or the ESG Data Convergence Initiative. Schreve mentions data on emissions in the value chain: “These are often still missing. We usually work with assumptions based on averages, depending on the country, the type of materials and the like.”
Grey area
With data from CSRD reports and all kinds of generally accepted guidelines, many due diligence processes can be completed successfully. Nevertheless, investors and companies will occasionally have to improvise if a deal is to go ahead. It is often possible to make adjustments, says Van den Boogerd. He gives an example of how data that is not immediately available can still be collected: a company’s CO2 emissions can often be derived from energy consumption according to the energy bill and other sources, especially in smaller companies.
Another point of attention is that companies and investors cannot avoid continuous monitoring of ESG performance and adapting to changing standards and insights. Not only in the due diligence phase, but also afterwards, says Van den Boogerd: “For example, we now have different views about which gases lead to climate warming and to what extent than a number of years ago. So, you cannot determine at once what kind of data you need and what you need to report on, but you have to continuously update it. If you don’t do this, you may even be at risk of being accused of greenwashing for not disclosing important data. Even if you do not consciously withhold things, the relevant data is not yet available or reliable.”
