Integrating ESG into your M&A strategy

What is ESG?

ESG is an acronym that has gained enormous prominence over recent years and is often thrown around vaguely in discussions of business models, investments and overall corporate trends. But what does it actually mean?

ESG, of course, stands for Environmental, Social and Governance. Environmental refers to a business’ impact with regards to factors such as climate, carbon emissions, pollution, energy usage and waste management. Social refers to a business’ approach to factors including employee treatment, health and safety, community involvement, working conditions and staff diversity and inclusion. Governance refers to a firm’s corporate governance and how problems such as bribery and corruption are tackled, diversity at board level, executive compensation, management structure, shareholder rights, privacy and cybersecurity etc.

ESG covers a wide spectrum of considerations and is designed to be incorporated into a business’ operations and forward strategy.

Since the term was coined nearly 20 years ago, ESG has moved from an initiative that was largely being pushed by groups on the periphery of the corporate world to a core consideration for businesses throughout the globe. Even since it made the rise to prominence for businesses, it has evolved further, going from largely being seen as a risk management consideration to a key value driver and a major barometer among investors for the sustainability and long-term prospects of a company.

Within M&A, ESG has seen a similar evolution. Going from a factor that was primarily associated with the due diligence stage of acquisitions and as a brand management tool, to a major motivating factor behind entire strategies, a central method of securing acquisition financing, a key driver of valuations and a core consideration when selecting target businesses.

As a result, active acquisitive operators can no longer ignore the importance of ESG to M&A and ought to acknowledge that it is not merely a necessity, but a huge opportunity to increase the scope and potential value derived from M&A activity.

How can ESG be incorporated into an M&A strategy?

Selecting acquisition targets
Companies with strong ESG credentials are increasingly seen as more lucrative and less risky acquisitions, as well as better long-term investments. However, ESG is a broad term and companies incorporating it into their M&A strategy will need to consider their own ESG aims, rather than just targeting businesses with strong credentials.

Buyers should seek to identify targets that not only have strong ESG credentials but that have credentials that align with its own strategic goals. For example, if a buyer is seeking to meet net zero targets, then companies with strong credentials in emissions reduction would make far more strategic sense as acquisition targets than companies focused on an aspect such as corporate governance.

By selecting targets that align with their own ESG strategy, buyers can improve their own credentials even further, helping to create more long-term value and strengthen its ESG-led growth strategy, bolstering brand reputation and potentially helping to attract funding from ESG-focused investors.

In order to assess the ESG performance of potential targets and select which ones to make a move for, buyers should review a company’s ESG policies, regulatory compliance and relevant performance metrics. One challenge that buyers might face is accessing the necessary information and converting it into a quantifiable, standardised form that accurately reflects the financial value of a target’s ESG credentials. Although this is helped by the growing onus on companies to report on things such as corporate governance and sustainability.

To this end, buyers operating ESG-focused M&A strategies will need to ensure that ESG considerations are put at the centre of their due diligence process, as well as their target selection process.

Due diligence and negotiation
The risks associated with ESG are now more pronounced and more costly than ever, meaning that buyers need to take ever-greater care during the due diligence phase to ensure that the associated risks are flagged up. Failure to do so can have serious implications in terms of brand image, shareholder value, investment prospects and, increasingly, regulatory and legal compliance.

This is especially the case in ESG-intensive industries (I.e. those in which ESG concerns are not merely a concern regarding how the company operates, but a major part of the way in which it operates – such as healthcare, energy, food production, manufacturing etc.)

Buyers incorporating ESG into their due diligence approach will need to take an incredibly close look at a target business’ values, culture and social responsibility. These are all factors that contribute to a company’s ESG credentials and, these days, form a vitally important part of how a target will be valued.

From a valuation perspective, buyers will also need to assess how a company plans to increase its ESG credentials. What are its ESG strategy and aims moving forward? If it has a solid, well thought out strategy in place, then this will increase its valuation accordingly. If, however, its plans are lacking (or non-existent), then the value will be driven down and buyers will need to decide whether to proceed and begin implementing a strategy post-acquisition, or to abandon the deal and move onto targets with better ESG records.

Given the huge importance that ESG now has in company valuations, buyers should use the due diligence phase not only to highlight where a business is performing well with regards to ESG, but also to root out areas in which it can improve, as these have huge implications for a firm’s valuation. Once a deal reaches the negotiation stage, any discoveries of where a firm’s ESG is weak can be used to help a buyer drive down the asking price and secure a better deal.

As the importance of strong ESG and the value that it can deliver increases, so does the risk associated with poor performance. A target business with a weak approach to ESG leaves itself open to a range of risks, from reputational damage to regulatory fines and supply chain disruption. This, in turn, should negatively impact the valuation a buyer places on the target.

In this regard, ESG is also an increasingly valuable way for buyers to strategise how they can increase the value of potential acquisition targets post-deal. By demanding that a target improve its ESG performance as a key condition of the acquisition, buyers can not only reduce the purchase price, but also immediately identify areas where a target’s value can be improved, such as by improving governance structures and investing in sustainability.

Therefore, ESG should also be a key consideration during negotiations over the contractual terms, especially in instances where improving a target’s ESG performance post-acquisition is a core condition of the deal. If a target’s ESG performance is lacking in some way, buyers should seek to incorporate goals and measures into the contractual terms. These could include monitoring and reporting, changing the governance structure or setting ESG-related performance targets.

Post-deal integration
Of course, not every acquisition will align seamlessly with the buyer’s ESG goals and even targets that most closely hew to a buyer’s strategy will require a degree of integration. Potential risks (and opportunities) will likely have been identified at the due diligence stage, meaning that the integration phase will already have some areas outlined where a target’s ESG performance can be improved – or where the target’s credentials can immediately be integrated to the buyer’s benefit.

An ESG-focused integration plan should outline how these risks and opportunities can be acted upon, such as by updating policies, reporting requirements or internal procedures, helping to ensure that the target’s ESG goals and values are aligned with the buyer’s. Employee engagement between the two companies will also be a key part of this, in order to bring both companies to a point where the staff are working towards common ESG objectives and values.

Other than employees, the buyer will also need to engage with stakeholders of both firms to communicate the ESG goals of the buyer and the target company and highlight how the acquisition helps both to progress towards their ESG objectives and bolster their credentials. This will help the buyer to build its brand as a sustainable, ESG-focused acquirer.

Finally, and perhaps the most important aspect of post-deal integration from an ESG perspective, the buyer should institute a rigorous monitoring and reporting regime. This will enable the buyer to track both how the target is progressing towards any ESG-related goals that were set out in the contractual terms, as well as gauging how the acquisition is contributing towards the buyer’s own aims.

The benefits of an ESG-focused M&A strategy

Attracting investment
Financing is hard to come by for M&A operators in the current climate. Amid ongoing economic uncertainty, lenders are tightening their financing conditions, meaning that buyers seeking outside capital to fund their M&A plans need to have watertight acquisition strategies to convince lenders to loosen their purse strings and make funds available.

In this regard, making ESG a core component of an acquisition strategy can be absolutely invaluable. It seems that, the higher up you get in the corporate world, the more important ESG concerns are to investors and the greater value they place in investments that help boost their ESG credentials.

According to a PwC study from 2021, 72 per cent of private equity firms screen potential targets for ESG risks and opportunities at the pre-acquisition stage. In other words, when identifying possible deals to pursue, ESG is one of the first things that private equity firms look at.

56 per cent of the PE firms polled by PwC said that they discussed ESG as part of their board agenda more than once a year, with 15 per cent saying that it was discussed at every single board meeting. In a corresponding survey from 2019, just 35 per cent of PE firms said that they discussed ESG more than once a year, indicating its growing importance. Given that the poll was conducted in 2021, the figure is likely to have increased significantly from there.

It’s not just private equity that is placing a growing value on ESG when selecting their M&A investments. Banks are also increasingly factoring ESG into their M&A financing, with some offering more favourable financing terms, such as lower interest rates and longer repayment periods, to buyers with strong ESG credentials.


TRXimpact is a digital transformation consultancy that works with clients ranging from not-for-profits and public services to large enterprises. According to the firm’s Purpose Director Bryony Wilde, TRXimpact’s aim is to deliver “impactful digital transformation in a way that benefits our people, planet and communities.”

In September 2022, the company secured a £30 million sustainability linked loan (SLL) from HSBC UK, which was earmarked the company’s UK acquisition strategy. The loan, which consisted of a £20 million refinance and a further £10 million revolving credit, is linked to three sustainability goals. These objectives are to reduce business CO2 emissions, improve gender and ethnic diversity and inclusivity and to enable employees to volunteer in local communities.

TPXimpact’s Chief Financial Officer Oliver Rigby said: "For the past few years we've focused on building out our capabilities across the UK. Moving forward our M&A activity will focus on adding new sectors and services and bolstering the existing capability of our integrated operations.”

"This new facility from HSBC UK will provide us with the liquidity we need to target acquisitions that align with that strategy, while also reinforcing our bold commitment to our ESG values at the same time."

HSBC UK Relationship Director Chris Winter added: "TPXimpact has seen consistently strong growth over the past few years and we're delighted to support the business as it targets expansion into new sectors and services.”

"Choosing to secure an SLL shows that TPXimpact is committing to linking its core values to its spending decisions, and we expect to see increasing numbers of technology businesses following suit."

HSBC UK received legal advice from TLT during the negotiation of the deal and TLT Partner Jon Stewart commented: "While Sustainability Linked Loans have been common at the top end of the large corporate space for some time, it is great to see the principles being adopted by upper mid-market organisations. It was a pleasure to work with the teams at HSBC UK to finalise this transaction and support a market-leading consultancy to achieve its ESG objectives."

There are also a growing number of investors operating with a dedicated ESG focus who prioritise investments in sustainable business practices. Such investors will be on the lookout for buyers with strong ESG credentials or who are seeking to improve their credentials via strategic, ESG-focused acquisitions.

Companies seeking to build an ESG-focused M&A strategy could also look at issuing green bonds. Green bonds are debt instruments used to finance business initiatives that have an environmentally friendly focus (such as acquisitive growth strategies). Buyers who already have strong ESG credentials may, again, find that they can issue such bonds at more favourable rates.

Whatever source of financing a buyer is looking at, integrating ESG considerations is a reliable method of attracting a wider range of options as well as more favourable terms. By demonstrating their commitment to ESG, buyers can stand out from competitors when seeking to access financing, something that is invaluable amid the current economic uncertainty and tight financing conditions.

Boosting valuations
One of the major benefits of focusing on ESG in acquisitions is that there is considerable evidence that companies with strong ESG credentials have higher valuations than companies with weaker ESG performance. As a result, companies that focus on improving their ESG performance via acquisitions could command significantly higher valuations should they ever seek a buyer themselves, or look to divest divisions as part of a strategic restructuring.

Deloitte recently undertook research assessing the market valuations attracted by companies with varying ESG scores. The research used data from Refinitiv, which produces an ESG score for companies based on over 500 KPIs, which are grouped into 10 categories and three pillar scores. Scores are computed into percentages from 0 to 100, with companies assigned an ESG rating based on this score. Ratings each cover a quartile of 25 and range from poor (0 per cent) to excellent (100 per cent).

According to Deloitte’s research, a 10 point-higher ESG is associated with approximately a 1.2x higher EV/EBITDA multiple. Meanwhile, for companies that increase their ESG score by 10 points, this improvement is associated with an approximately 1.8x increase in EV/EBITDA multiple.

To look at a specific sector, a March 2022 analysis by Janus Henderson of valuations at technology companies also showed a positive correlation between ESG performance and valuations. The research showed that 60 per cent of multiples across companies with similar characteristics demonstrated a valuation premium attached to companies with higher ESG scores.

Similarly, 54 per cent of multiples demonstrated a valuation premium for companies with strong ESG performance against P/E ratios and enterprise value vs sales metrics. 72 per cent of multiples, meanwhile, showed a valuation premium when assessed against EV/EBITDA.

The research also showed that, while companies with weak ESG may demonstrate strong earnings growth, they are unlikely to receive the kind of credit afforded to peer companies with stronger ESG performance.

Other studies have also demonstrated the correlation between ESG performance and valuations, with a Harvard report finding that stronger ESG performance attracted higher valuations, even after controlling for factors such as profitability, size and industry. A study by MSCI, meanwhile, found that firms with strong ESG performance generally had higher price-to-book ratios than counterparts with weaker performance.

There are numerous reasons why buyers would attach higher valuations to companies with strong ESG performance. Primarily, of course, they help buyers to bolster their own ESG credentials, attract M&A funding and generate long-term value.

Beyond that, however, companies with strong ESG performance typically have reduced operational costs, higher brand value as a result of their improved reputation and more resilience against a huge array of risks, ranging from governance issues such as regulatory fines and reputational damage, to things such as climate change.

The ESG value premium
The ESG value premium is a term referring to the positive financial benefits that companies attain from investing in ESG, the idea being that prioritising ESG means a company is more likely to create long-term value and generate higher returns than counterparts with weaker ESG credentials.

Advocates of the ESG value premium point to the lower volatility and higher long-term returns typically generated by companies with stronger ESG performance. Adding credence to the theory is the fact that investment firms that have incorporated ESG into investment strategies have often reported higher returns and lower risks in the long-term.

The ESG value premium is a broad term encompassing the many value-adding elements that a strong ESG strategy and performance can deliver. This can include the company improving its reputation among customers, investors and staff, potentially helping to boost customer loyalty and brand value, as well as improving talent retention and increasing innovation and productivity.

Companies with strong ESG performance are also more resilient to risks, such as climate change and supply chain disruption, which can help to lower its operational costs and boost profitability. Strong ESG credentials can also mean a company avoids risks such as regulatory fines and the associated reputational damage that can come from poor governance.


VPS is a global marine fuel testing advisory business owned by Fremman Capital. The company is a market-leading firm in fuel testing, inspection and advisory for the shipping industry, with operations in Singapore, Houston, Rotterdam and Fujairah.

The company tests marine fuels and lubricating oils, with its findings containing quality, reliable analytical data, interpretation and advice to help ship operators run more efficiently, reduce emissions and optimise fuel costs.

In February 2023, the group acquired Manchester-based Emsys Maritime, a firm that produces marine emissions measurement technology for a global customer base including shipyards and ship operators. The firm’s technology is supported by a digital platform providing real-time environmental insights into vessels and enabling operators to improve efficiency and meet compliance requirements.

The company’s products include the new Emsys Analytics software platform, which provides ship operators and charterers with a comprehensive, real-world data stream that enables them to manage ESG reporting requirements.

According to VPS, the acquisition would help it to meet rapidly growing demand from shipping customers by complementing its digital decarbonisation service.

Commenting on the deal, VPS CEO Dr Malcolm Cooper said: “In Emsys Maritime, we have acquired a company with a strong technical capability and excellent reputation, helping us to deliver our ambition to be the leading service provider in fuel performance optimisation and emissions reduction.”

“The addition of real-time emissions measurement data complements our existing marine fuel analysis data to provide a comprehensive understanding of greenhouse gas emissions in the maritime sector. The integration of real-time emissions monitoring into our existing portfolio of digital decarbonisation services (which currently includes Maress, NOxDigital, CORE and PortStats) within a single, unified platform will provide added value throughout the VPS digital customer journey.”

“This new flow of information will assist us in providing our customers with the tools required to understand, control and reduce greenhouse gas emissions, moving the industry forward toward achieving carbon emission reduction targets for 2030 and beyond.”

Emsys Maritime Founder and Managing Director Simon Brown added: ”Emsys Maritime was established to provide the maritime industry with the most accurate and reliable emissions measurement tools to enable ship operators to manage their environmental and regulatory requirements and goals.”

“The acquisition by VPS allows Emsys Maritime to accelerate its already strong growth into new market areas and customer sectors. The integration of our real-time data into the VPS digital decarbonisation platform will create an industry leading portal which will help the wider shipping community on it journey towards net zero”

Operational improvements
Of course, acquiring companies with strong ESG performance can also deliver a wide range of operational improvements to their core business and, for many ESG-focused buyers, this will be the central motivation behind their acquisition strategy.

Acquisitions with a focus on ESG can help the buyer to become better at identifying risks relating to ESG, such as environmental and social changes, supply chain and geopolitical disruption and the growing expectations that customers, investors and numerous other stakeholders have surrounding corporate governance.

ESG-focused acquisitions can also help to improve operational efficiency, helping buyers to identify and implement best practice in areas such as labour management, diversity and inclusion, energy efficiency and waste reduction. These, in turn, can help to deliver cost savings, improved productivity and higher profitability.

Conclusion

ESG has increased in prominence to a point where it is likely to be a relevant consideration in the vast majority of M&A transactions. However, buyers should not simply see it as a requirement to be satisfied in order to meet compliance standards or avoid reputational damage.

ESG is, on its own terms, a huge driver of value and, as a central component in an ambitious M&A strategy, can help buyers to generate long-term value, select acquisition targets with high growth potential, enhance their financing options for future acquisitions and unlock the skills, capabilities and credentials to improve their own ESG performance.

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