M&A Transactions & ESG – Match or No Match?

Three letters have been on the minds of investors for some time now, not just in recent times: "ESG." ESG stands for Environmental, Social, Governance, and translates to "Environment, Social, and Corporate Governance." Sustainability now encompasses not only environmental protection but also social and corporate climate.

But what does this mean for small and medium-sized enterprises, and what impact does it have on transactions?

ESG, what is it, and what goals does it aim to achieve?

The goal is to provide objectively verifiable information about the extent to which companies pursue sustainable strategies on a social, ecological, and corporate level using ESG criteria. This is done by quantitatively assessing the development of individual criteria over time using various metrics and mapping them in a uniform scoring system. Companies can choose their focus individually. The resulting ESG score is then assigned to the respective company and can be compared with the ESG scores of other competitors.

ESG, is it even relevant to me?

Here's a simple answer: "Yes." Small and medium-sized enterprises are increasingly confronted with ESG aspects. ESG is no longer a passing trend and not just a temporary buzzword used by some DAX corporations' marketing departments to promote their environmental strategies. ESG will continue to gain importance in the coming years. Therefore, small and medium-sized enterprises should already be addressing sustainability and see it as an opportunity to make their businesses future-proof.

As mentioned earlier, the goal is not to fulfill all ESG criteria equally (and often it is not practically or economically feasible to do so). To make implementation manageable or if a criterion cannot be covered due to industry-specific reasons, it makes sense to prioritize and focus on one ESG criterion and align the existing business model with it. Here's an overview of the ESG criteria:

• Sustainable Business: The maxim should be long-term stability and healthy growth over short-term profit maximization. A sustainable corporate strategy and planning reflect the sustainability agenda.
• Environmental Protection: Resource-efficient production and distribution of products, minimizing energy consumption, and avoiding unnecessary travel activities are the principles.
• Corporate Governance/Corporate Identity: Developing corporate strategies that prioritize responsibility towards employees, customers, and suppliers, promoting equality of opportunity, and supporting further education.

ESG & M&A Transactions – Match or No Match?

ESG criteria have a direct and indirect impact on a company's value. Directly, for example, by saving costs through resource-efficient and efficient use. But the indirect factors should not be underestimated. Studies have shown that ESG compliance already has a positive effect on a company's reputation today, and the trend is upward!

In this context, it is not surprising that ESG is increasingly coming into focus for investors and playing a growing role in transaction processes. While in the past, central questions in a corporate purchase included the purchase price, the development of the company's metrics, synergies that could be realized after the purchase, it is now observed in the market that ESG aspects are increasingly moving into the focus of interested parties. One reason for this may be that acquiring a company with a better sustainability performance, for example, helps improve one's own ESG balance. Even the acquisition of a minority stake can have a positive impact on one's own ESG compliance.

Furthermore, with a majority acquisition, there is an opportunity to fundamentally transform one's own business model and the associated value chain towards sustainability. The examination is carried out, especially as part of an ESG Due Diligence, which requires interdisciplinary expertise from transaction, IT, legal, energy consulting, as well as auditing and compliance.

This part requires good preparation from the selling company and a sufficient understanding of this topic. The interested party assesses data and facts. Therefore, the company must be able to provide sufficiently meaningful data and documents that depict the current status of the implementation of the ESG aspects relevant to the company.

ESG is also playing an increasingly important role in acquisition financing, such as full or partial debt financing. Here, one is increasingly dependent on the subjective assessment and ESG rating of the financial service provider. In general, the worse the ESG rating of the company to be acquired, the more expensive the financing; in the worst case, the financing may fail.

Companies that have no or only an inadequate strategy on this issue are at a disadvantage with certain buyer groups and often have to anticipate discounts on the purchase price.

What can be concluded?

Developing and establishing a sustainable corporate strategy is sensible and protects the company from negative financial impacts in the future. Without an ESG-compliant business model, successful operations and a successful company sale will become increasingly difficult to achieve in the future.

THE AUTHOR AS WELL AS YOUR USUAL CONTACT PERSONS ARE HAPPY TO ANSWER ANY QUESTIONS YOU MAY HAVE!

Christian Schon
schon@tigges.legal
+49 211 8687 284