Understanding how ESG impacts M&A

Despite the greenwashing scandals and culture wars against ESG, investors are moving to take #climatechange into account for future #investments.

The recent acquisition of Greentech Capital Advisors for $100m by Nomura should be on the radar for smaller funds with mid-cap assets, $10 million to $ 100 million, usually the target for #acquisition. The #deal indicates the shifting focus of more prominent #investors on the hunt for the assets and companies of the future. These are the emerging smaller businesses that will contribute to the #circulareconomy. Within the ecology of the finance system, these #businesses are currently being funded by #familyoffices, smaller #funds, or university incubators.

Understanding the long-term strategy

Despite a year where the headlines have been dominated by ‘greenwashing’ scandals, the eruption of culture wars around #ESG and the exposure of #ESGratings as poor tools to create a market, it is essential to follow the #money. Therefore, Nomura assumes that M&A — and financing deals related to clean energy, innovative #greentechnology, next-generation transport, and related sectors — will increase volume and value dramatically. They are not the only ones thinking along these lines.

The direction of capital does not lie.

The critical point is that money and the direction of #capital are very revealing; it does not lie. If anything, markets tend to follow trends and movements. Investors, for all the robust individualism, are like the seagulls following Eric Cantona’s trawler, moving in the same direction seeking their dinner. They are now identifying their targets which they see will create a return in the future. The #energytransition plays a large part and will see the removal of older high carbon, less profitable companies. Demand is for companies that will drive the #circulareconomy. Sectors of interest are #electrification, #lowcarbon solutions, #storage, #transportation, and #semiconductors.

Putting a price on future risk

While I regularly listen to the opinions of my friends who are climate deniers, critical of ESG and impact, as to how “investors are not paying attention, and climate does not matter”, my conversations with analysts in banks, #VCfunds and #PEfirms provides a different story. Valuations and investment decisions are governed by future risks and opportunities driven by climate change. Science-based measured ESG disclosure considers the positive and negative impact factors (financial risk and opportunity). Prominent investors are engaged in the disclosure’ pass the parcel’ game where they try to get #carbon, #climate, and #biodiversity risk off their books and avoid ‘stranded assets’ or unviable #supplychains .

Buyers and sellers will focus on the same metrics.

Each deal will still undergo the usual due diligence and acquisition process for valuation. This covers: the capital characteristics, metrics, #strategy, governance, portfolio rationale, management efficiency, organisation fit and size.

Disclosure of forward-looking risks and opportunities

As voluntary disclosure becomes mandatory, investors are looking for the future positive and negative impact factors. These are measured by CDP, SBTI, TCFD, TNFD covering, carbon, climate, and biodiversity. In addition, double materiality or context-based materiality endorsed by the UN must be calculated. Finally, the translation of these science-based measures into financial risk is what buyers and investors want to understand.

ESG due diligence factors

The conventional approach by the buyer in evaluating the seller remains the same. A few top-line ESG factors, but not exclusive, will include:

#Regulation: the buyer will want to ensure the target is #ESG compliant with its reporting market, ensuring that the business has established the ESG frameworks at its core and across its supply chain. Think of carbon 1,2,3 — think of employment rights and impact on the production process. Understand the global regulatory push and how it impacts the business.

Contractual obligations: sellers can expect the buyer to investigate if ESG risk of customers and suppliers have been calculated. For example, if the target is a food company in Europe who is reliant on supply from sub-Sahara Africa, what is the climate risk and impact on the supply source? Buyers will question if the evidence is not in place measuring exposure and why not. These questions create #riskfactors for the #buyers and make sellers look unprepared.

Investors: The buyer will come under pressure from its #financing source, usually banks or more prominent investors whose #investment criteria are now is being shaped by downward #disclosure which is being driven regulators and shareholders. While many investors will say they don’t believe in ESG, the fact is, no matter how buccaneering, they all want to eliminate risk.

Assurance and Fiduciary duty: much of the standards, disclosure, double materiality, and how science-based data is translated into financial information are still under development. It will take a decade before we are there. A huge temptation is for boards and CFOS to be creative and engage in ‘greenwashing”. This would be a mistake as they are covered by section463 of the Companies Act 2006 (CA 2006) which states: Directors of a company are liable to compensate the company for any loss suffered because of an untrue or misleading statement included in the #statutory director’s report, strategic report, directors’ remuneration report, or #corporategovernance report”.

Reputation: Always plays a part in any #transaction; the proof and the metrics must underpin any good story or investment case by the seller. The buyer’s intelligence gathering will gather the details required and thus be able to make an accurate call on ‘greenwashing’ aspects. Sellers should think as to how they can construct a strong ESG narrative that will drive the valuation.

Smart M&A goes the science route.

If we look at deal fundamentals, any deal going ahead will rest on the buyers’ requirements and its ESG strategy. One option is to go light touch and use ESG ratings, which do not accurately indicate #impact or #systemchange. However, given the desperate state of the ESG rating tools, #market savvy buyers, sellers, and their investment committees will require evidence of science-based measurements along the key themes to safeguard valuation and future return.

Gaining an advantage

The opportunity for small-cap asset owners and #companies is to move early. Start early to understand the ESG factors. Establish the ESG scaffolding and data collection, which are the twenty-one themes any investment committee is looking for in a conventional or ESG acquisition.

Start early

If sellers want to appeal or gain access to these opportunities, they need to start thinking about how they can put the reporting structures in place even to be considered or get through the buyer’s door. Likewise, if buyers want to gain value and return, they must answer the question: Will this business exist in ten years, and what value will it add to my portfolio?

Keep ESG simple

ESG and Impact capital is just a subset of the larger capital markets. Investors want to find compliant companies that will build future economies and drive the transition. Conversely, investors want to avoid #assets that, due to #climate, #carbon, and #biodiversity loss, will either fail to deliver value or, because of the failure of the management to pivot to market realities, #climatechange, #innovation, and #demographic change will disappear.

We’ll get there in the end.


Originally published at https://www.linkedin.com.

Jonny Mulligan

I am a consultant working with CEOS, CFOS, the boards of companies and investors in the ‘real economy’ who need to respond and develop a coherent strategy to the ESG transition. In a rapidly changing world, I support them define their ESG purpose, vision, and mission, which is critical to their long-term success, valuation, and profitability.




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