Environmental, social and governance (ESG) practices are becoming increasingly important for businesses, but addressing them to improve M&A outcomes and for the greater good comes with a multitude of challenges.

This session during the annual M&A Conference at Wharton San Francisco, which was held virtually this year, considered ESG in the diligence process, ways to mitigate risks surrounding these objectives, and the merit of using M&A to advance them.

ESG EQUATES TO M&A SUCCESS

Companies with high ESG scores tend to have historically high stock prices, according to Margot Miller, Global Legal Head of M&A, Treasury, & Antitrust at Anheuser-Busch InBev and a member of the M&A Leadership Council.

Investors, shareholders and boardrooms are increasingly aware of this.

Higher ESG scores also tend to be associated with higher employee morale, activity, attention, equity returns, customer engagement and brand development.

“Arguably the debt markets are a bit ahead of the equity markets,” Miller continued.

“Here lenders have really seen that the potential impact of ESG risks long-term and short-term can impact the creditworthiness of a business. Over time, I think companies have seen that their access to capital can be tied to ESG.”

FIRST STEP TO IMPROVING ESG

“Your sources of capital do care about this, and therefore you should too,” said Pat Tucker, Managing Director in Abernathy MacGregor’s New York office.

However, because of a lack of metric standardization, Tucker highlighted the difficulty in identifying and comparing ESG KPIs with multiple frameworks, raters and evaluators in the mix.

It has become incredibly difficult for companies to know who to use, what to lean on and where to start first.

Tucker recommended starting at the Sustainability Accounting Standards Board (SASB) framework that the investor community is currently rallying around.

“That is a good, very practical, very reasoned way to begin to look at disclosure,” he said.

DON’T GET STUCK IN THE WEEDS

But rather than be too focused on a particular standard, Miller recommended a piecemeal approach where initiatives are implemented based on the issues that matter most to investors and the company.

Sonalee Parekh, SVP of Corporate Development (M&A and Integration) and Investor Relations at Hewlett Packard Enterprise (HPE), agreed with this patchwork approach until there is a convergence of standards and guidelines in the market.

“Just having an ESG framework that’s about ticking boxes is not going to change the mindset,” Parekh said.

“I think it does need to be about long-term vision and purpose. It needs to come right from the top.”

WHERE ESG FITS IN THE DEAL PROCESS

When looking at deals, particularly large acquisitions, Parekh said due diligence considerations can range from how diverse the C-suite is to how much energy the company uses.

HPE has very bold carbon footprint targets that could be put at risk with the wrong acquisition, highlighting how important ESG has become as simple platitudes are no longer enough – stakeholders require KPIs and “skin in the game”.

However, because of the lack of standardization, Miller warned against using data-driven ESG compatibility services when looking at deals.

HOW TO PROTECT YOUR OBJECTIVES

Companies in general are starting to realize that just confirming a target’s historical compliance with ESG targets is probably not sufficient anymore, Miller noted.

On the seller side, she said companies were increasingly incorporating post-completion undertakings when it comes to ESG.

Custom reps and warranties are increasingly coming into play to guard against the potential risk.

The panel also recommended getting a buy-in from key management, aligning ESG KPIs where possible to integrate performance measures and goals.

BROADCASTING ESG SUCCESS CAN INCREASE PREMIUMS

Parekh highlighted how ESG communication around a deal, internally and externally, is extremely important.

“The bottom line is you need to establish that line of communication with your shareholders,” she said.

“And then when you have opportunities to go out and do a bit of a charm or PR offensive on something, if you have great things on the ESG side to say, of course include them in the press release, include them in the internal comms, include them in the investor presentation.

“I do believe … there will be a premium paid. Investors will be willing to pay for strong governance and strong ESG metrics. So if you’ve got them, this could be potential for a little re-rating.

“None of us here say that we should do this just because of valuation upside, we should do it because, guess what, it’s the right thing to do, and we’ll all benefit, but if there is this premium valuation that goes along with it, and we seem to all agree on that and I haven’t really heard any push back to that, then of course it should be front and center of the way we communicate.”