Shareholders and investors holding management to account on ESG targets expect merged and acquired firms to be aligned to the same ESG goals. ESG due diligence enhances decision making as it takes a long-term and holistic view of the company. Failure to effectively analyse the ESG framework of a target company can result in exposure to post-deal reputational risk and, ultimately, a decline in shareholder value.
These concerns led to the poor IPO performance of food-delivery service Deliveroo in March 2021 – institutional investors declared they wouldn't support it due to misgivings about its ESG performance. This trend is likely to persevere as society’s concern for environmental and social matters continues to shape and develop investor and shareholder ESG goals.
ESG metrics are increasingly used to determine the valuation of businesses, as ESG performance is linked to the financial performance and the value creation of a business. Companies are embedding ESG into their core business practices, which in a fast-paced geopolitical world opens them to risk if they want to stay true to their ESG targets.
Company boards are finding themselves under increasing pressure to provide assurance over their ESG pledges, which in the absence of mandated reporting standards and mounting investor expectations, exposes them to the risk of 'greenwashing' to attract potential investors. ESG due diligence will become necessary in addressing this risk and become common practice during the M&A phase.
To effectively conduct due diligence, practitioners must keep track of ESG changes, understand the relevant ESG issues for the business and focus on crucial areas for understanding the ESG framework of the target company. These areas will include the following priorities:
- Integration of ESG goals and the tone from the top, including employee training and ability to meet ESG requirements of the acquiring or merging partner
- Understanding of key ESG risks, including supply chain risks related to the nature of the business
- Availability and depth of ESG management information, including data quality
- Effectiveness of whistleblowing policies and procedures, including resources and systems in place to manage and track investigations
- Identifying and understanding ESG red flags through both data analytics and open-source research
It's important to devote time and specialist resources to ESG due diligence. This will often include the same mix of specialisms and skills required in forensic due diligence, including forensic accounting, anti-financial crime, data analytics and corporate intelligence.
With the right skills, technology and knowledge, data analytics enables the efficient analysis of large data sets, providing a true ESG picture of the target. The ability to understand and process data for analytics is essential for verifying ESG disclosures and identifying red flags. An early understanding of the target company’s data will be essential on completion of the M&A in ensuring integration with the acquirer or merging partner's own ESG targets.
ESG red flags identified through data analytics can be explored further through corporate intelligence building a holistic view of the target’s ESG profile through internal and external data sources.
The future will continue to see an increase in ESG due diligence. Integrating ESG into forensic due diligence will be the key to unlocking and understanding the ESG risks of an M&A deal and safeguarding long-term shareholder value. To be effective, practitioners must be multi-skilled and able to focus on the crucial areas for understanding and identifying red flags within the target's ESG framework.
If you're concerned about any of the issues raised here, get in touch with Andrés Galiñanes.
