How public ESG reporting factors into private deals

ESG, which stands for environmental, social and governance, was once just a reporting methodology designed for socially responsible investing. It’s a form of inclusionary screening, highlighting what investors want to include in their portfolio. This reporting has typically been part of public company disclosures. Now it’s increasingly prevalent in private M&A deals.

“What investors and acquirers are looking for in ESG are companies that embrace environmental, social and governance initiatives — companies that are committed to greater sustainability, greater equity and inclusion and diversity, and better governance,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank.

The exact meaning of each of these ESG categories, however, can differ among buyers and investors, and it’s unclear how these issues distinguish themselves from the typical considerations of M&A due diligence. Still, more private-deal investors and acquirers — both private equity and strategic — are grading companies on their performance in each of these categories, making this something business owners looking sell, exit their business, or take chips off the table must increasingly understand.

Smart Business spoke with Altman about ESG reporting and what private business owners contemplating a transaction should understand.

How did ESG considerations enter the private realm?

The gradual trickle down of ESG reporting from public to private has come in part through greater disclosure at the public-company level. Some of that could be from the recent social movements the U.S. has seen. There’s also greater concern on the part of consumers who increasingly want to do business with companies that are at least moving in the right direction on ESG factors. So disclosures have become a bigger deal, not just in the public but also in the private space as more stakeholders want to align themselves with companies that align with ESG.

How do ESG standards differ from traditional diligence?

It’s not entirely clear how ESG reporting differs from the reporting typically requested during the standard due diligence that occurs when an owner sells his or her business. For many, these are metrics that have been considered for a long time as part of a deal. It’s not often that a buyer is willing to take on a business that is detrimental to the environment, that doesn’t consider a variety of stakeholders in everything it does, or that isn’t well-governed.

There may be deals that could largely be driven by ESG factors, while others may only take ESG into consideration. That means some buyers firms could require a level of ESG standing in order to consider a company within the specific industry niche they target. Others may be looking to acquire businesses that are going to help them improve their overall ESG standing. And still others might look for acquisitions that have quality business fundamentals that fit their portfolio that may incidentally have some great ESG factors associated with it as well.

What should sellers know?

For sellers, it comes down to situational awareness. It means understanding the ESG trend within their industry as well as the industry’s leading ESG companies. In a world where there’s no clear definition of what ESG means, a relative definition is meaningful. Industry standards, then, can be a good gauge — and, for those trying to be a leader in the ESG space, it can help define goals.

Potential sellers will want to look at their business and attempt to gauge their environmental, social and governance standing relative to the industry. But keep in mind that ambiguity means ESG standards will largely be defined by the potential buyers who likely have their own metrics. Research the potential industry factors to be in a better position to address questions from potential acquirers.

Understanding how ESG will impact a sale or liquidity event requires further identification, possibly education, but definitely a conversation. ESG in the private M&A space has yet to be clearly defined. But what is clear is that more and more buyers are concerned about a company’s ESG profile. Sellers, then, need to understand acquirers’ value stream in order to maximize value in a transaction.

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