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March 13, 2023

How to Perform M&A Due Diligence on Sustainability

As the business world shifts towards a more environmentally and socially conscious approach, the significance of sustainability in M&A has become increasingly prominent. In light of this, companies are now considering the environmental, social, and governance (ESG) initiatives of their target companies before making any acquisitions. In this article, we explore how to perform M&A due diligence on sustainability, with insights from Sarah Thuo, Chief Operating Officer of IBM Sustainability Services.

“Change is inevitable, and a business that doesn’t change is usually a business that’s dying away. Embracing change and understanding how to thrive in that change is the way to go with sustainability.” - Sarah Thuo

Importance of sustainability 

The push for sustainability in the business world is driven by several key factors, including:

  1. Climate Change - As the effects of climate change become more apparent, businesses are recognizing the need to adapt their operations to minimize their impact on the environment.
  1. The Intersection of Social Issues and Business - Companies understand that their success is intertwined with the well-being of the communities they operate in.
  1. Stakeholder Pressure - Shareholders, employees, and customers are demanding more transparency and accountability from companies regarding their ESG initiatives.
  1. Increased Regulation - Governments around the world are now mandating sustainable business practices, with Europe leading the way.

The benefits of incorporating sustainability into business operations are clear. Companies that embrace sustainability enjoy:

  1. Stronger Brand Equity - Companies that are environmentally and socially responsible benefit from positive media exposure and stronger brand equity, which can translate to higher financial valuations and improved financial performance.
  1. Increased Customer Loyalty - As customers become more conscious of the sustainability initiatives of the companies they support, they are more likely to be loyal to companies that align with their values.
  1. Attracting Talent - Younger generations are seeking careers that align with their values and purpose, making sustainable businesses more attractive to top talent.
  1. Lower costs - Sustainable companies often have lower costs of capital, making them more attractive to investors.
  1. Future-Proofing - As sustainability regulations continue to evolve, embracing sustainability helps companies stay ahead of the curve and future-proof their operations.

Performing diligence on sustainability

If seeking to assess a company's compliance with ESG key performance indicators (KPIs), start with performing sustainability diligence. The relevant KPIs will vary depending on the industry, geographic scope, and the company's own commitments. The following steps will guide you through the process:

Step one: Understand the ESG KPIs of the target company. 

Step two: Assess how they are performing compared to the expected standards set by regulations, customers, or peers. 

Step three: Evaluate their future performance based on their operations, growth goals, and supply chain changes.

Do’s and don’ts of ESG diligence

Some of the do's include:

  • Thoroughly reviewing the target company's ESG initiatives, rather than simply relying on their reporting.
  • Staying informed about the sustainability trends and ESG initiatives of their peers in the industry.
  • Understanding the existing and upcoming regulations surrounding sustainability.

Some of the don'ts include:

  • Taking things at face value.
  • Being cautious of "greenwashing" - when companies make false or exaggerated claims about their sustainability efforts.
  • Don’t solely focus on environmental issues. While emissions are important to make sure you have a sustainable world, they are not the only issue that should be on the table. Outside of emissions, there are social and governance issues that are important to many stakeholders.

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