ESG Due Diligence in Practice

ESG considerations must not be treated as a mere footnote in the M&A process; rather, they should permeate the entire process from start to finish. However, the considerations differ depending on whether one is on the buy-side or the sell-side of an M&A transaction.

ESG from a Buyer’s Perspective

Just as a company’s business determines the scope of a traditional legal due diligence, ESG factors must also be tailored to the specific industry and business of the target company. For instance, are environmental matters the most pertinent to the business of the company, and if so, which types of environmental matters? Alternatively, it may be the case that environmental matters play an insignificant role, and that focus should instead be on labor rights, ethical business practices, or the company’s management structure.

After having identified the ESG issues relevant to the business of the target company, these must then be addressed in the information request list directed to the potential seller. Any ESG matters of significance should be investigated thoroughly, and the client must be informed and involved in discussions regarding any ESG concerns which arise. It is also beneficial for the potential buyer and its advisors to broaden the ESG scope from the customary liability areas to include an evaluation of the company’s general ESG-preparedness. For example, to what extent does the company monitor and assess relevant ESG data points, such as environmental impact, employee diversity and board composition. Does the company have policies and processes in place, and to what extent are these applied in practice? Further, ESG matters should be given attention during negotiations between the parties, and should potentially influence the conditions of the contract, indemnities for uncovered risks, and the final purchase price. Finally, the legal advisors, among others, must guide the buyer forward post-closing, as they address and mitigate any risks identified during the due diligence process. This requires legal advisors to have a thorough understanding of ESG matters.

ESG from a Seller’s Perspective

From the outset, a potential seller should ensure that the target company aligns with as many relevant ESG requirements as possible. A proactive approach prepares the company for the potential transaction, and in case a sale does not proceed according to plan, it positions the company advantageously for a future divestment. Further, identifying ESG concerns in the target company, before the business is subject to a due diligence review, can be advantageous in two additional ways. Firstly, being well-prepared on ESG matters, strengthens the seller’s negotiation position, and avoids unfavorable informational asymmetries between the parties. Secondly, a well-informed seller can maintain full transparency through the material provided in the virtual data room and can therefore disclose potential ESG issues to the buyer. As a result, the likelihood of post-closing claims under the warranties on unknown risks in the share purchase agreement is minimized.

In summary, it is evident that ESG considerations differ depending on whether one is on the buy-side or the sell-side of an M&A transaction. However, in both cases, the more actively and strategically ESG matters are integrated in the process, the greater the benefit for the parties.