In a recent post (“Environmental, Social and Corporate Governance: What are the Risks, Really?”), we discussed the various risks, trending issues, and emerging concerns arising from environmental, social, and corporate governance factors (“ESG”). As noted previously, neglecting ESG considerations can result in a number of risks to a company, including risks associated with the reputational, financial, and legal impacts of handling ESG issues poorly. We also observed how managing ESG issues well can enhance corporate value and performance, and create competitive advantages for companies. Given these emerging risks and opportunities, it is perhaps unsurprising that ESG has begun to play a larger role in the M&A context in recent years.
One area where we have seen the influence of ESG in M&A transactions is in the due diligence process. ESG due diligence can help buyers identify key ESG-related risks, which may affect the buyer’s reputation, the valuation of the target, as well as the structure of the deal. While some ESG diligence may relate to topics traditionally covered in the ordinary due diligence process, ESG due diligence typically goes further and focuses on the values, culture and social responsibility of the target. For instance, traditional due diligence typically addresses the target’s compliance with labor and employment laws; however, ESG due diligence may address issues related to workplace diversity, gender inequity, sexual harassment and workplace misconduct.
The specific ESG issues that a buyer will be most concerned about will depend on a number of factors, including the buyer’s expectations, the target’s industry and where the target operates. It may also depend on whether a buyer is seeking financing for the transaction and whether that lender has adopted a specific set of ESG standards. Increasingly, buyers’ investors, including limited partners in private equity funds, are also pushing for more ESG considerations in the acquisition process. Some ESG issues that may be relevant in a transaction involving a retailer include climate change and greenhouse gas emissions, human rights and labor standards, supply chain transparency and workplace and supply chain diversity.
Another area where we have seen the influence of ESG in M&A transactions is in the negotiation of transaction agreements and the protections that are being built into these agreements. Transaction agreements may address certain ESG issues through representations and warranties, such as environmental matters, privacy and data security, labor relations and corruption and anti-bribery. With the growing focus on ESG by various stakeholders, however, buyers may consider negotiating additional ESG-related representations and warranties. For instance, so-called “Weinstein” clauses or “MeToo” representations requiring targets to disclose misconduct allegations are increasingly being added to transaction agreements. Such clauses may form the basis of an indemnification claim after closing or potentially allow the buyer to refuse to close the transaction.
Post-closing, ESG should continue to remain a focus during the integration process. Buyers should develop a plan for aligning the target’s ESG policies with those of the buyer. Buyers should also develop a plan addressing any material ESG-related risks that were identified during ESG due diligence.
We expect ESG considerations in M&A transactions to continue to develop. New ESG-related risks and opportunities will emerge and corporate strategies will need to adapt to identify opportunities and mitigate risks.