ESG Considerations In M&A Transactions

In the last few years, investors are placing a significant emphasis on ESG considerations in their investment decisions. Consequently, numerous businesses and organisations are incorporating ESG into their operations and overarching business strategies.

INTRODUCTION

ESG is an acronym for “Environmental, Social and Governance” and refers to established practices that organisations adopt in their business activities to alleviate an adverse impact on the environment, social aspects and their internal governance.

Within an organisation, ESG compliances assess the capacity for growth, client and employee retention, addressing a diverse range of issues such as shareholder rights, board management, decision-making processes, environmental regulations, climate change and human resources matters to name a few.

In the last few years, investors are placing a significant emphasis on ESG considerations in their investment decisions. Consequently, numerous businesses and organisations are incorporating ESG into their operations and overarching business strategies. Recently there has been an unprecedented growth of ESG issues in M&A deals, with the potential for deals to falter if ESG concerns remain unresolved.

ROLE OF ESG IN M&A TRANSACTIONS

ESG policies have become an integral part of due diligence exercises and a standard amongst global investors.

While there is no set framework for ESG policies / compliances in India, there are several compliances such as environmental laws, employment laws, corporate governance regulations which an organisation in India needs to follow and the non-compliances of which will directly impact the ESG credentials of the organisation.

Considerations related to ESG should be incorporated into due diligence processes, encompassing compliance with data protection regulations, employee retention programmes, disclosures, and reporting obligations dictated by applicable laws. Other critical aspects include adherence to anti-corruption guidelines, engagement with customers and related parties, compliance with employee health, benefit, and safety regulations, as well as environmental obligations. To better analyse ESG risks during M&A transactions, inquiries regarding the following points are essential:

(i) Does the seller already have an established ESG strategy?

(ii) What is the seller’s approach towards ESG compliances?

(iii) How does the board of the seller perceive the understanding and implementation of ESG strategies?

(iv) Are there any existing management incentives aimed at promoting ESG within the organisation?

(v) What ESG disclosures have been made by the seller?

(vi) What measures has the seller implemented to mitigate the ESG risks identified by them?

ESG CONSIDERATIONS IN TRANSACTION DOCUMENTS

Upon the completion of due diligence exercises, when ESG risks are highlighted in such reports, the buyer / acquirers proceed to negotiate basis their findings in the due diligence reports.

Several ESG-specific provisions are finding their way into transaction documents, including but not limited to the following:

(i) Sellers are required to make specific representations and warranties concerning highlighted ESG risks in diligence reports;

(ii) Price adjustments based on ESG risks;

(iii) Specific indemnities for non-compliance with ESG requirements;

(iv) Closing actions to implement ESG structures in a precise manner; and

(v) Tailor-made sector-specific covenants related to risk factors, such as child labour, unsafe work environments, workplace discrimination and data protection.

Market studies show that in the last 10 years, ESG-compliant organisations are far better in terms of return on investment, debt to equity ratio, dividend pay-outs, market presence and increased sales.

With the constant evolution of ESG compliances, as a part of the post-closing compliance requirements, a purchaser usually requires periodic assessment reports from the target in relation to ESG risks, resilience and readiness to address the identified risk. These periodic reports will help to identify risk exposures and foster measures to mitigate them.

CONCLUSION

In conclusion, as the business landscape continues to evolve, integrating ESG considerations into M&A processes has emerged as a crucial strategic imperative. The recognition that sustainable and responsible business practices are not just ethical but also financially prudent has transformed the way companies approach M&A transactions. By prioritising ESG factors, organisations can enhance long-term value, mitigate risks, and contribute positively to society. As stakeholders increasingly demand transparency and accountability, integrating ESG considerations into M&A decisions is not just a trend but a fundamental aspect of responsible corporate governance. Moving forward, companies that embrace and embed ESG principles in their M&A strategies will likely navigate the complexities of the business world more successfully, fostering a culture of sustainability, resilience and enduring success.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.