In today's society, unsustainable business practices affect a company's future profitability. In the world of private equity and investors, portfolio composition choices are already largely based on what a company's ESG score is like.
Sustainability is no longer an afterthought in SME mergers and acquisitions either. It has now become one of the most important factors in an acquisition. Whether it's the choice of whether companies go into business with each other, knockout factors in a due diligence investigation or as a topic at the negotiating table when it comes to warranties and indemnities.
What is ESG?
ESG stands for Environmental, Social and Governance,in Dutch environment, people and governance. It is also summarized under the term "sustainability. In business terms, it means the sustainability of a company in all areas, from its impact on the environment to its dealings with people throughout the supply chain. ESG legislation includes all laws and regulations on the topics of environment, people and governance, and that's very broad. It basically covers everything about how companies treat their employees, the impact they have on the environment and how they set up their organization and run their business. As a society, we believe that this can be done more sustainably and better. Our ethical standards about this are also changing. Consider the discussions on social media about the abuses in the fashion industry, intensive livestock farming and dumping of waste in poor countries. Want to know more about this? Then read this article.
How does ESG affect company value?
ESG affects several factors that determine a company's value.
- Risk management
Being smart about ESG reduces risk, for example by saving costs in the long run, making the company less susceptible to fraud, and making its supply chain more stable. More and more investors are taking this into account. - Reputation
The better a company performs on the ESG, the better its reputation. That ensures greater customer loyalty, and also makes the company more interesting to employees in times of staff shortages. Moreover, for SMEs supplying large corporations, they can only continue to serve those customers if they are ESG proof on all fronts. - Access to capital
Strong ESG performance makes it easier to raise capital and also discounts capital costs. Investors rate companies that focus on sustainability and social responsibility higher. Banks also pay attention to this.
- Indicator of future success
ESG is increasingly seen as an indicator of a company's future success. Not only in large companies, but especially in SMEs. Companies that score well on ESG often have a better reputation, more stable operations, attract talented employees and are seen as reliable business partners. This leads to better operational performance, higher profits and, in the long run, also more value creation.
ESG in the different steps of the acquisition process
ESG plays a decisive role in corporate acquisitions at various stages of the acquisition process.
- Selection process and company value
On the buyer's side
Already when selecting a potential "target" (the company to be acquired), ESG plays a major role. The value of the target is increasingly determined by the answer to the question of how ESG-proof a company is. If a company makes major gaps in ESG, the value of the company drops and a lower purchase price will simply be paid. After all, the new owner will then still have to make substantial investments: think of insulation of the business premises, finding newer (more sustainable) suppliers or raw materials and correcting skewed tax policies.
On the seller's side
As an SME entrepreneur, you have spent years building your business, perhaps even over several generations. Then you certainly don't sell your business to just anyone. Moreover, you also have an obligation to your staff, to transfer them well to a buyer who will continue to take good care of them. A company that is known to treat its staff badly does not seem like a good option then. But what about a foreign company from the US or Asia that you don't otherwise know? Perhaps it is not unwise to do some research into their ESG scores anyway.
- Due diligence
When conducting due diligence for a potential acquisition, companies should consider ESG risks and opportunities. This includes assessing the environmental performance, social impact and policy structure of the target company. By including ESG factors in the due diligence process, potential environmental, social and policy risks and opportunities are identified in a timely manner. Analysis of these factors allows buyers to identify potential risks that could damage the value or reputation of the target company. - Purchase Price Determination
We mentioned it above: a low ESG score immediately results in a lower purchase price. It does not mean that you have to be the best in class, but certain basic principles have to be in order. Otherwise, you run the risk of getting considerably less for your company than hoped for.
- Value creation
Suppose the ESG score of the company to be acquired is lower than yours as a buyer. Then improving that score after the purchase creates immediate value. Implementation of the buyer's ESG policy and changes in that area with the help of the buyer, can realize cost savings, allow your company to operate more efficiently from now on, bring in better customers and discover new markets. The reverse can also be the case;that the buyer actually adopts the purchased company's sustainability efforts and thereby creates value for its own company. For example, by adopting a revolutionary new, sustainable, more environmentally friendly production method, purchasing different raw materials, and so on. - Stakeholder management
We mentioned this too: companies that score high on ESG are attractive employers for young and talented employees. The young generation has a great need for meaning, even when it comes to work. They want to be proud of the company they are part of. Being conscious of the environment, living conditions and human rights is part of this. Those who have satisfied employees radiate this. This has a direct influence on how customers are treated. Having an eye for your company's impact on the immediate environment ensures that you have a positive image. It also ensures that you have fewer problems when it comes to licensing or other government interference, for example environmental and environmental permits or exceptions.
In short, ESG is of critical importance to companies and investors and plays an increasing role in assessing a company's sustainability and responsibility. In the context of M&A and corporate acquisitions, ESG helps manage risk, create value and manage stakeholders.
Our vision
We believe that sustainable companies are more successful in the long term and that is exactly what we strive for. Therefore, during the PREPARE phase , we pay attention to your company's ESG score and provide targeted advice on how it can be effectively improved in order to remain successful in the long term and thus increase the value of the company.
In the MERGE phase we will, depending on which 'side' you are on, advise you on how to pay attention to the ESC aspects in the due diligence and the ESG score of the target plus the consequences if it turns out to be substandard. The ESG score of the target will also play a role in the purchase price and contract negotiations.
In the INTEGRATE phase , we pay attention to ESG within the framework of the success factors that we believe underlie a successful mode of integration.
Do you have questions about this? Or would you like advice on integrating ESG criteria? Please feel free to contact Esther Tromp (E: esthertromp@law-firm.international, T:+31655741267).
