ESG due diligence on the rise in the mergers & acquisitions scene

26 January 2023 5 min. read

The ESG megatrend is increasingly entering the word of mergers & acquisitions, according to new research by KPMG. Dealmakers are keener to embed ESG factors into their decision-making across the full deal life cycle, and on conducting an ESG due diligence along the way.

KPMG’s report concludes that ESG can become a disruptive factor in a company’s M&A processes, similar to how the topic is reshaping strategic decision-making in the boardroom. Overall, four out of five dealmakers told the firm that ESG considerations are now firmly on their M&A agenda.

But while the maturity of ESG considerations varies strongly across organisations, most respondents told the researchers that they also plan to expand the scope and maturity of how they apply ESG rigour to their transactions, from linking ESG strategy to M&A strategy, all the way down through to operationalising processes in pre-deal and integration phases.

Are ESG considerations currently on your M&A agenda

For its study, KPMG surveyed over 150 active dealmakers across Europe, the Middle East and Africa. In addition, in-depth conversations with senior dealmakers were held. “Something exciting is happening at the nexus of mergers & acquisitions and environmental, social, and governance,” said Florian Bornhauser, lead author of the report.

More than two thirds of organisations said that they would be willing to pay a premium for a target that demonstrates a high level of ESG maturity, with almost one-in-five stating they would pay a premium of 5% or more, and half willing to pay between 1% and 5%.

With ESG more on the radar, dealmakers on both sides of the table (buy-side and sell-side) expect ESG due diligence to become more commonplace. According to KPMG’s survey, the number of dealmakers who expect to conduct ESG due diligence ‘very frequently’ is set to nearly double.

How frequently did you / do you expect to involve an ESG DD on your deals?

“For sellers, this means that increasing levels of scrutiny from buyers must be expected – even for assets and dealmakers that may historically not have been subject to stringent ESG due diligence enquiries,” said Bornhauser.

Notably, the study further found that much of the drive towards more due diligence builds on actual value, and less so on pressures from regulators or stakeholders. The top reason mentioned by the survey respondents was that they believe in the monetary value of identifying risks and upsides related to sustainability at the pre-signing stage.

Why have you conducted / are you going to conduct ESG DD on your deals (multiple choice)?

An ESG due diligence?

While dealmakers have for decades been acquainted with conducting due diligence on commercials, synergies, financials or human capital, the ESG space still is relatively new. This is turn means that dealmakers encounter a range of greenfield challenges, confirms the KPMG report.

To start with, defining the scope of ESG in the context of transactions. The next step is to translate key objectives – for example greenhouse gas emissions, climate change, biodiversity, soil contamination, water contamination, air pollution for the ‘E’ or anticorruption, business ethics, responsible tax records, whistleblower mechanisms for the ‘G’ – into actual key performance indicators.

What are the key challenges you have encountered, or you expect to encounter in conducting ESG DD (multiple choice)?

To cut through this complexity, “mindful upfront scoping is paramount.” Yet, this is a step that many investors are struggling with. The survey results indicate that selecting a meaningful, yet manageable scope is the number one challenge faced by ESG due diligence practitioners. Number two is trying to put a monetary value against these key performance indicators.

Nicolas Ribollet is a partner at KPMG in Bahrain and has over the course of his career seen many deals come to fruition. Asked how dealmakers can best incorporate ESG into their existing due diligence frameworks, he said: “Based on my experience, dealmakers need to start establishing links to the company’s overall sustainability strategy.”

“The next step would be to develop blueprint for ESG due diligence, both in terms of its intellectual framework, as well as from an organizational perspective. Before implementing those plans, dealmakers need to ensure the corresponding budget and capabilities to ensure ESG due diligence delivers on the corporate ESG strategy.”

How well do you make use of the findings of your ESG DD reports to establish a post-closing action plan?

Reflecting on the report’s main conclusions, Bornhauser said: “Overall, the study finds that ESG due diligence is increasingly important. But, at the same time, there is little consensus around what it actually means, and dealmakers are divided about how best to incorporate the approach into their existing due diligence frameworks.”

Besides putting in the miles to crystallise ESG due diligence, the topic is “often underfunded, not always aligned to the organisation’s overall ESG strategy, and lacks state-of-the-art tooling that underpins many other due diligence processes.”

“The importance of getting ESG due diligence right has never been clearer, and significant focus and progress is expected in the field in the coming years.”