Why ESG is sinking business takeover negotiations

Experts

Mergers and acquisitions are being abandoned over environmental, social and governance concerns, with buyers unwilling to risk reputational damage in pursuit of growth.
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Mergers and acquisitions are being abandoned over environmental, social and governance (ESG) concerns, with buyers unwilling to risk reputational damage in pursuit of growth.

Pitcher Partners’ annual Dealmakers report, released last week, reported almost a quarter of respondents (23%) had abandoned at least one deal in Australia over ESG in the previous two years.

It is a stark illustration of how much weight investors are now placing on ESG information when conducting due diligence, particularly in looking at offshore supply chains. About 86% of Dealmakers’ respondents stated that ESG was a factor in negotiating most deals across the last 12 months.

The risk of investing in another business that is subsequently found to not conform to ESG in one or more ways is potentially a reputational disaster, particularly for listed companies.

It’s a risk that few are now prepared to wear.

As one respondent said, “There was a lot of time wasted to review the available ESG reports and disclosures, which were not up to the required standards.”

Some buyers were willing to invest in improving ESG standards of target companies, but that relied heavily on knowing where the company was falling short. 

Dealmakers made it clear that the absence of data when performing due diligence was more of a threat than known and documented problems.

Because of a heavy focus on qualitative data, investors and business leaders have yet to find a consensus on how to report on all the aspects that could be covered under ESG.

Chief among the challenges cited was:

  • the issue of integrating the information with financial data (23% of respondents);
  • confusion about, or a lack of, reporting standards (20%);
  • an inability to obtain information (20%); and
  • difficulty in measuring the future risk of ESG factors (18%).

Investors want to ensure that the reported earnings are really there but also that they are sustainable and won’t evaporate after the business is finally acquired because of poor publicity about its health and safety regimen or weaknesses in its supply chain.

A white paper produced by CPA Australia in 2022 examined ESG disclosures across six Asia-Pacific economies: Australia, New Zealand, Singapore, Hong Kong, Mainland China and India. It noted that while greater disclosure on ESG is a common goal, each nation was moving at different speeds and paths.  

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The lack of clarity around ESG standards and information remains a challenge, which respondents said complicated the process of gathering information among buyers or collating it from the seller’s side. 

ESG is not solely responsible for a longer due diligence process, but it is a factor in a process now more protracted than before the pandemic when it was often faster to sell a business than a house.

Finance, tax and all sorts of due diligence are taking longer at the moment, as bidders take more time to understand earnings and gain some insight into what the future will look like.

So, what actions should business leaders be taking to satisfy investors? 

Potential red flags should be clearly understood, particularly in the early stages of planning for a sale, if they are being targeted for takeover or if stakeholders have raised concerns about reporting standards. 

THE LIST

As financial backers and stakeholders take more time to understand ESG threats and assess a company’s future, developing a comprehensive risk management framework is essential.

Risk management frameworks help evaluate traditional potential threats to business, such as competition, market changes, loss of key people, and new technological advances.

ESG factors are not nearly as tangible but are no less a threat to the profitability of a business. 

The absence of a standardised level of reporting can make comparisons to other transactions and companies difficult, but demonstrating that risks have been planned for gives investors greater confidence.

Lenders and financial institutions themselves are increasingly reluctant to fund a transaction that falls short on ESG performance or cannot demonstrate sound reporting because the spotlight is also being shone on their role.

A comprehensive risk framework helps alleviate the concerns of potential investors and financial institutions and goes a long way to understanding ESG threats and reducing exposure to them.

Dealmakers continue to see Australia as a favourable destination for M&A opportunities, with 87% of respondents planning transactional activity within the next 12 months and 56% saying they expect M&A conditions will improve in 2023.

While cost-of-living pressures and rising inflation raise concerns over consumer discretionary spending, realistic deals can be made.

But the poor quality of ESG data collection and reporting spells trouble for any business looking to sell in this climate.


James Beaumont is a Corporate Finance Partner at national accounting and business advisory firm Pitcher Partners Melbourne.


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