Could ESG Mean Make or Break in Today’s M&A Landscape?

By Alistair Lester, Global Co-CEO of M&A and Transaction Solutions, Aon

As the world began to recover from the COVID-19 pandemic, global M&A activity soared, surpassing $5 trillion for the first time last year. Driven by the reopening of the world economy, supportive fiscal and monetary policy, and the eagerness of both strategic buyers and private equity investors to deploy capital, new dealmaking opportunities are rapidly on the rise.

Although for many dealmakers the COVID-19 crisis is now moving into the rear-view mirror, uncertainties still remain, such as ongoing challenges related to geopolitics, government regulation and pandemic-related disruptions.

We’re therefore seeing increased investment in technology and other specialist due diligence, as buyers become more dependent on third-party deal finance in today’s high inflation environment.

Environmental, Social and Governance (ESG)-related factors are also driving significant change in M&A, buoyed initially by investor and consumer demand, and now by legislative developments across multiple jurisdictions.

In fact, a recent report from Mergermarket data revealed that 60% of global dealmakers said they have walked away from an investment due to a negative assessment on ESG issues at a potential target, while 52% admitted that their ESG investment strategy has had a positive impact on overall investment returns.

For dealmakers, understanding specific ESG requirements for businesses is one of the key ways to success. The challenge, however, is getting it right.

The need for ESG scrutiny in M&A transactions

Despite the heightened interest, ESG is still an extremely complex space to navigate due to the myriad of sustainability standards, frameworks and metrics for ESG reporting. Failure to correctly address ESG scrutiny in M&A transactions today could spell disaster further down the line, obstructing risk reduction and long-term value generation.

Regardless of the challenge, consideration of ESG factors in M&A is undeniably rising. According to our recent research, a stark 90% of dealmakers predict an increase in scrutiny of deals for ESG implications over the next three years, with almost half (48%) believing the increase will be significant.

Businesses today have no choice but to put time and effort into understanding how they can satisfy those ESG regulations. Although there is no one-size-fits-all approach for ESG, buyers will increasingly scrutinise a target’s ESG credentials during the due diligence process, paying particular attention to reputational risks and regulatory concerns.

However, this could lead to further repercussions. With many organisations already facing significant pressure due to an incredibly high inflation environment, navigating ESG compliance might lead to the demise of some businesses.

The ‘c’ behind ESGc

In light of the current global geopolitical conditions and countless breaches, another major priority in the M&A sector today is cyber resilience.

In fact, with cybersecurity being increasingly tied into the ESG agenda because of its role in defining company’s integrity, these two elements should be regarded as two sides of the same coin.

To successfully find a balance between risk management and value creation in the sector, businesses need to double down on developing an effective cyber resilience strategy. They must acknowledge their societal responsibility in protecting personal data and organise their assets accordingly. Not only will it help to safeguard consumers, but also mitigate any issues with the company’s image, operations and finances.

Defining ESG parameters upfront

With the rapid growth of ESG scrutiny, it is becoming increasingly apparent that ESG performance and commercial strength should go hand in hand.

That is why it is now more important than ever for buyers to work with the company to define ESG issues upfront. This will involve establishing specific areas of interest in the early stages of the process and ensuring buyers get all the information they need to make an informed decision. If buyers put off their ESG assessment until later in the process, it could have a significant negative impact on the deal.

In light of the recent shift of workforce and consumer demographic, another piece of the puzzle is addressing the social pillar of the ESG strategy. The implementation of effective diversity, inclusion and employee engagement strategies right from the start will significantly help organisations to gain a competitive advantage in the market.

ESG: make or break in today’s M&A landscape

From tackling climate change risk to dealing with social issues, investment in ESG is no longer a “nice to have” in business practice. It is a pivotal process minimising the future risk of massive profit loss, cyberattacks, and litigation.

To succeed, it is time for companies to embark on an ESG journey and embed ESG considerations into the enterprise at all levels. Ultimately, those who stay on top of the ESG agenda over the next 12 months—who attack ESG assessment with thoroughness and vigour⁠—will be doing their future selves a favour.