The Evolving Role of ESG in M&A Transactions: A Competitive Advantage

The M&A process has undergone a paradigm shift. Traditionally, the due diligence process focused on financial, operational, legal, and tax considerations. However, with the rise of ESG matters, the M&A process has evolved to incorporate these critical aspects as well. Buyers, investors, and stakeholders are now concerned with companies’ adherence to climate regulations, human rights, and corporate governance standards. Further, the understanding that ESG factors can influence a company’s financial performance has now been established. In today’s world, ESG-related social issues have gained significant prominence, and with the rapid circulation of information on social media, decision makers have realized that the success or failure of a company can hinge on its reputation.

The Drivers of ESG Aspects in Private M&A
ESG matters have been codified in both EU and Swedish law, notably through the Corporate Sustainability Reporting Directive and its incorporation into Swedish law. While the regulations primarily apply to listed and large companies, they are already driving change in the actions of decision makers in small and medium-sized companies as well. This occurs when a company within the direct scope of the regulations is required to provide information on the ESG performance of other, smaller companies in its value and investment chain. In this way, the regulations create a ripple effect across the private sector as all businesses are increasingly held to a similar standard. The combination of the regulatory requirements and the growing societal pressure makes ESG matters unavoidable, even for smaller companies.

Unlocking Competitive Advantages Through ESG
The competitive advantage through ESG matters lies in staying ahead of the curve. Establishing a strong ESG track record can enhance the valuation of a target company by reducing perceived risks and offering long-term growth potential. From a potential buyer’s perspective, proactive attention to ESG aspects mitigates the risk of misallocating attention and financial resources during the evaluation of a company. Quickly identifying ESG-related deal-breakers can save a potential buyer valuable time and capital. If the potential buyer decides to proceed with the transaction, knowledge of identified ESG issues can provide new leverage points in the negotiations leading up to the acquisition of the company and may influence the final purchase price. Conversely, ignoring ESG aspects can have long-lasting negative consequences, such as regulatory penalties, a growing risk of investor and consumer repercussions, and devastating reputational harm.

The Future of ESG Due Diligence
ESG matters will only continue to grow in importance in the coming years. As regulatory demands rise and societal pressure mounts, a delayed response to legal requirements and to public opinion will not be sufficient. Companies, investors, and their advisors must act proactively to stay ahead. The sooner we engage with ESG matters, the greater the return on investment, the long-term benefits, and the competitive advantage.