Will ESG factors create or destroy value in your next deal?

21% of CEOs recognise the need to transform in order to remain viable

Twenty-one per cent of Irish CEOs believe that their organisation will no longer be economically viable in ten years if they continue on their current course. The outlook is bleaker globally, rising to 39% when all 4,410 surveyed CEOs are accounted for. Businesses are increasingly in a race to reinvent and for many, ESG has become the lynchpin of future success. These topics are maturing into ESG due diligence criteria with important implications for the mergers and acquisitions (M&A) landscape. Insights drawn from a cross-section of recent deals speak to what we consider ESG ‘orange flags’, which signal that dealmakers should proceed with caution to limit risk and enhance value. The six orange flags are:

1. Unethical marketing: this is problematic for dealmakers because it means messages are inconsistent with reality—they don’t align with regulation, stakeholder sentiment, or public positions taken by acquirers.
   
2. Reputational risk: failure to meet regulations, internal targets and stakeholder expectations can lead to negative attention, knocks to consumer and client confidence, and loss of revenue.
   
3. High risks in supply chains: this is emerging more frequently as wars, conflicts and trade tensions persist across global routes. Indeed, these risks are heightened by threats from physical climate events.
   
4. Disengaged employees: evidence of disengaged employees is gaining prominence in M&A with greater scrutiny of governance, employee development and retention, workforce diversity and equal pay more likely to be factored into diligence.
   
5. The transformative deal that isn’t: the deals-driven ESG opportunities for venture capital and private equity houses are well understood. However, investment brings risk if outcomes are overpromised or underdelivered.
   
6. Inadequate non-financial disclosures: what is reported and what is not is an ongoing issue, as is the transparency and validity of data. For dealmakers, inadequate non-financial disclosures are an important orange flag.

In addition, dealmakers should also ask themselves a number of fundamental ESG questions such as:

1. Does the target entity have a documented ESG strategy?
   
2. Has the target entity allocated sufficient resources to ESG initiatives and activity?
   
3. Does the target entity have a policy for the use of scarce resources?
   
4. Can the target entity provide data and information on customer perceptions of their company from an ESG perspective?

In doing so, they will get a clearer view of the company’s true position on ESG and minimise any risk of greenwashing.

Learn more about the six orange flags for dealmakers here. This article was first published in strategy+business magazine.