ESG Factors are Carrying Increasing Importance in Mergers and Acquisitions Dealmaking

ESG Factors are Carrying Increasing Importance in Mergers and Acquisitions Dealmaking
Mergers and Acquisitions

03 of 08

This insight is part 03 of 08 in this Collection.

September 15, 2023 16 mins

ESG Factors are Carrying Increasing Importance in Mergers and Acquisitions Dealmaking

ESG factors are gaining significance in M&A transactions, supporting dealmakers in the due diligence process — and for some, they are the ultimate success or failure of a deal.

Key Takeaways
  1. ESG considerations are increasingly being utilized for evaluating companies’ sustainability, social responsibility, and corporate governance practices.
  2. Throughout the M&A journey, ESG is now considered a crucial component — from target selection and screening to post-merger integration.
  3. Corporate and private equity investors expect ESG scrutiny in deals to increase over the next three years.

Environmental, social, and governance (ESG) factors are gaining importance in merger and acquisition (M&A) activity globally, as dealmakers on both sides of the table have come to recognize the growing relevance of each component in the success or failure of a deal.

Why ESG Matters

From target selection and screening to post-merger integration, ESG considerations are driving investment decisions to help companies meet their own sustainability ambitions and capitalize on the opportunities of a net-zero economy. Buyers are increasingly scrutinizing whether the target company is acting in a socially responsible manner.

According to Aon’s M&A Risk in Review, 96 percent of corporate and private equity investors say they expect ESG scrutiny in deals to increase over the next three years, with 48 percent expecting it to increase significantly.

Whether the transaction is public or private, ESG issues increasingly require the same level of due diligence that is typical for other workstreams, including financial, legal and human capital. Dealmakers recognize that any acquisition also brings with it a series of ESG risks that can be highly material, hard to find, and subject to shifting goalposts.

“Regulators are demanding disclosures at much greater granularity, investors are demanding greater transparency, and employees also want to see commitments matched by actions,” says Luise O’Gorman, Aon’s Global Head of ESG Transaction Advisory Services.

Globally, overseas buyers are expanding requests for ESG-focused due diligence when purchasing companies, and governments around the world are stepping up reporting requirements. Specifically:

  • In India, three of four Chief Experience Officers said they were assessed on ESG performance before finalizing a deal.1
  • As part of its green transformation project, Germany is working to meet its environmental targets, accelerating the legal and social transition from corporates and individuals.
  • China is also making a push for ESG and is said to be planning to make ESG disclosures mandatory for firms listed on domestic markets.2

How ESG Components Impact M&A Dealmaking

Failure to disclose environmental and social issues, or realize there is a disconnect between ESG commitment and action, creates a post-transaction risk of litigation. Such risks may be intensified in public transactions given the rising number of ESG disclosure requirements in many markets.

There is no one-size-fits-all approach to ESG. It should be tailored to the particular sector of a company and its maturity. “For one target, this may be the carbon footprint and the credibility of net zero targets; for another, it may be the labor standards and human rights in the supply chain that may pose a more material risk,” says Laurence Hesleden, Aon’s Director of M&A and Transaction Solutions in Australia.

Each component of ESG may impact M&A deals in different ways:

  • Environmental

    Forecasting the consequences of climate change is still a developing science. Investors, however, must assess how the changing climate will impact a potential target. This includes physical risk, such as the increased frequency or impact of extreme weather, and transitional risks including policy, technology, market, and reputational risks.3 Also, long-term, open-ended investments, which can be relevant to real estate and infrastructure, can carry a more significant exposure.

    Aon’s M&A Risk in Review found that nearly one in four corporate and private equity investors say environmental litigation creates the most concern with respect to potential disputes in a deal — up from just two percent in early 2022.

    Investments in the transition to a low-carbon economy are becoming increasingly important, affecting companies’ costs and margins. This is especially true in certain industries, such as the energy and transportation sectors. In many cases, M&A can be used to acquire technologies or capabilities to help build and transform these environmental efforts. However, in the technology sector, carbon footprint reduction is not a core consideration as building a diverse organization may take more focus, which can bolster a brand’s reputation and lead to increased revenue.

  • Social

    Social risks include how a company affects its employees, suppliers, contractors, and consumers. It also includes the associated negative social impacts, which can occur through direct operations and value chains.

    Failing to address human rights, inclusion and diversity, fair pay, privacy of sensitive customer data, or investing in projects or sectors with severe health implications is risky, as these all fall under social risks. As the international legal framework around ESG issues continues to change, so does conducting human rights due diligence in the context of M&A.4

    This evolving legal framework includes the recently adopted Corporate Sustainability Due Diligence Directive within the European Union. The directive establishes a corporate due diligence duty, which includes core elements of identifying, ending, preventing, mitigating, and accounting for negative human rights and environmental impacts in the company’s own operations, subsidiaries, and value chains.5

  • Governance

    Governance involves the assessment of decision-making timing and quality, the integrity of the process, its structure, and the distribution of rights and responsibilities across different stakeholder groups — all in support of positive societal impact and risk mitigation. Two core governance components include:

    • Corporate governance: This relates to the way a company “governs” itself through policies, processes, and controls to achieve compliance and secure transparency.
    • Business integrity: This focuses on how a company avoids corruption and bribery, as well as openly engages with politically exposed individuals who may cause reputational risk to the brand.

Beyond each of the ESG component points that should be considered for a target company, supply chain risks also fall under each of the ESG components and must be considered as well. These are some of the key considerations:

  • Carbon footprint
  • Exposure to extreme weather events, which can lead to business interruptions
  • Human rights and labor standards
  • Business ethics and corruption

“The extent to which you can analyze these points in the context of a deal and deal timelines, however, can be challenging,” adds O’Gorman.

Steps for Buyers and Sellers to Successfully Navigate the ESG Process During M&A

To provide optimal valuation, buyers and sellers in M&A transactions are encouraged to consider these best practices:

  • Sellers
    • Prepare due diligence around ESG plans, including disclosure requirements.
    • Establish a task force to monitor how the firm is upholding ESG obligations and take necessary actions across all ESG elements to provide the best chance of optimal valuation.
    • Solidify the firm’s ESG ratings.
    • Have a compelling ESG story to share with prospective buyers.6
  • Buyers
    • Implement a due diligence process to fully understand the risks of the target company and use these insights to make informed decisions about deal terms.
    • Look for evidence of greenwashing — a continual concern — along with litigation and regulatory actions.
    • Use ESG as a test. If the company is not living up to its ESG commitments, what else is it missing?

For many years, ESG has been an underutilized tool in M&A transactions. However, ESG is here to stay. Recent trends have brought its growing importance to the forefront as a method for both mitigating risk and enhancing value.

Contact the Aon M&A team for more information on the impact of ESG in an M&A transaction.

1 Why Environmental, Social and Governance Factors are Gaining Prominence in M&As
2 Sustainable Fitch: Taxonomies, Mandatory Climate Disclosures and ESG Fund Rules Gain Ground
3 ESG Due Diligence is the New Non-Negotiable for many Infrastructure Investors
4 Human Rights Due Diligence – ESG Impact on M&A Transactions | Pillsbury Law
5 Corporate sustainability due diligence |European Commission
6 Use These 5 Tips to Build a Compelling ESG Story in Today’s Evolving D&O Market | Aon

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

Terms of Use

The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.

Aon's Better Being Podcast

Our Better Being podcast series, hosted by Aon Chief Wellbeing Officer Rachel Fellowes, explores wellbeing strategies and resilience. This season we cover human sustainability, kindness in the workplace, how to measure wellbeing, managing grief and more.

Cyber Labs

Stay in the loop on today's most pressing cyber security matters.

Cyber Resilience

Our Cyber Resilience collection gives you access to Aon’s latest insights on the evolving landscape of cyber threats and risk mitigation measures. Reach out to our experts to discuss how to make the right decisions to strengthen your organization’s cyber resilience.

Employee Wellbeing

Our Employee Wellbeing collection gives you access to the latest insights from Aon's human capital team. You can also reach out to the team at any time for assistance with your employee wellbeing needs.

Environmental, Social and Governance Insights

Explore Aon's latest environmental social and governance (ESG) insights.

Q4 2023 Global Insurance Market Insights

Our Global Insurance Market Insights highlight insurance market trends across pricing, capacity, underwriting, limits, deductibles and coverages.

Regional Results

How do the top risks on business leaders’ minds differ by region and how can these risks be mitigated? Explore the regional results to learn more.

Human Capital Analytics

Our Human Capital Analytics collection gives you access to the latest insights from Aon's human capital team. Contact us to learn how Aon’s analytics capabilities helps organizations make better workforce decisions.

Insights for HR

Explore our hand-picked insights for human resources professionals.

Workforce

Our Workforce Collection provides access to the latest insights from Aon’s Human Capital team on topics ranging from health and benefits, retirement and talent practices. You can reach out to our team at any time to learn how we can help address emerging workforce challenges.

Mergers and Acquisitions

Our Mergers and Acquisitions (M&A) collection gives you access to the latest insights from Aon's thought leaders to help dealmakers make better decisions. Explore our latest insights and reach out to the team at any time for assistance with transaction challenges and opportunities.

Navigating Volatility

How do businesses navigate their way through new forms of volatility and make decisions that protect and grow their organizations?

Parametric Insurance

Our Parametric Insurance Collection provides ways your organization can benefit from this simple, straightforward and fast-paying risk transfer solution. Reach out to learn how we can help you make better decisions to manage your catastrophe exposures and near-term volatility.

Property Risk Management

Our Property Risk Management collection gives you access to the latest insights from Aon's thought leaders to help organizations make better decisions. Explore our latest insights to learn how your organization can benefit from property risk management.

Technology

Our Technology Collection provides access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities of technology. Reach out to the team to learn how we can help you use technology to make better decisions for the future.

Top 10 Global Risks

Trade, technology, weather and workforce stability are the central forces in today’s risk landscape.

Trade

Our Trade Collection gives you access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities for international business. Reach out to our team to understand how to make better decisions around macro trends and why they matter to businesses.

Weather

With a changing climate, organizations in all sectors will need to protect their people and physical assets, reduce their carbon footprint, and invest in new solutions to thrive. Our Weather Collection provides you with critical insights to be prepared.

Workforce Resilience

Our Workforce Resilience collection gives you access to the latest insights from Aon's Human Capital team. You can reach out to the team at any time for questions about how we can assess gaps and help build a more resilience workforce.

More Like This

View All
View All
Subscribe CTA Banner