Environmental, social, and corporate governance (ESG) is rapidly becoming front of mind for regulators, investors, customers, and employees—and it is rising to the top of corporate agendas as well. As ESG gains in importance, it is becoming a mark of business quality. Many now view a well-devised corporate ESG strategy as a positive indicator for long-term revenue growth.

In our recent global survey of 281 M&A executives, 65% expect their own company’s focus on ESG to increase over the next three years. This view extends to M&A. More than half of surveyed respondents either see ESG leadership as justifying higher deal valuations or expect this to be the case in the future, indicating a need for buyers to appropriately assess and value their targets’ ESG performance.

But are corporate buyers accounting for ESG in their M&A process today?

Not yet, according to our survey. Only 11% of respondents say they extensively assess ESG during the deal-making process on a regular basis. In fact, out of 10 elements of the corporate M&A process, ESG was the least-emphasized dimension. Many are struggling to determine how to embed the process of assessing the ESG implications of an acquisition into their M&A strategy.

Some companies are ahead on this curve. By incorporating ESG into their M&A process, they have set themselves up with an advantage in pursuing value creation opportunities and a head start in meeting their ESG imperatives.

For example, when an industrial company recognized as a sustainability leader in its industry pursued a provider of infrastructure technology, energy implications were a major consideration. The sustainability edge is an important differentiator for the industrial company’s real estate customers, who own assets ranging from commercial buildings to data centers. Increasingly, those customers were demanding more environmental solutions, both to manage energy costs and to meet ESG commitments of their own. The infrastructure technology company proved to be an attractive target. It provided products for an energy-intensive and growing business segment, and it had the added differentiation of being as effective as alternatives but significantly more sustainable. This type of investment is central to the industrial company’s strategy, which emphasizes offering greener solutions that are good for the environment, good for its customers, and good for business.

Similarly, a European food producer known for its healthy and environmentally friendly products used the diligence process to understand a potential North American acquisition target’s performance on a range of ESG factors. The diligence determined that the target, an ingredient company, had a positive environmental profile that surpassed competitors and strong positioning on consumer health that could benefit the acquirer. But the same research also unearthed risks in the target’s diversity, equity, and inclusion (DEI) profile. The diligence enabled the acquirer to clearly see how the ingredient company’s strengths in sustainable packaging, in particular, could be used to appeal to its own customers and emphasized this in the value creation plan; it also revealed the specific actions that the acquirer needed to take to begin addressing the target’s DEI issues on day one.

By beginning to unlock ESG as an M&A priority and a factor in delivering deal value, these companies move ahead of the majority of companies that have yet to evolve their M&A models to account for the growing sophistication of ESG. They’ve discovered that the traditional check-the-box approach to sustainability issues falls short. When assessing targets, they dig deeper on issues ranging from greenhouse gas emissions to DEI, and from business ethics to supply chains.

Linking corporate ESG strategy to M&A

Success in this arena begins by linking overarching corporate ESG strategy to M&A strategy. It means making sustainability a part of each deal thesis. It means using corporate priorities as a benchmark to assess each potential deal and find assets that will advance existing ESG initiatives as well as create economic value.

This value can come from multiple sources. For instance, in the consumer products industry, 68% of our surveyed executives see ESG’s value in helping them gain share by improving their brand image to appeal to changing consumer preferences. Leaders in the energy sector, meanwhile, more commonly cite ESG initiatives for helping them meet requirements or expectations of investors and financiers to lower the cost of capital. Across industries, ESG measures can also add value by helping manage costs (e.g., waste reduction) or by helping attract and retain top talent—a particularly critical goal in today’s competitive talent environment.

Of course, not every asset will advance an underlying ESG goal, and other business rationales will often justify pursuing a given asset, regardless of the ESG footprint. Even in such situations, performing diligence on a target’s ESG record is critical to underwriting the deal. There may be real financial costs that the buyer will incur to integrate and advance the target’s ESG capabilities up to the acquirer’s standards, for example.

Infographic

Five Big Things to Know about M&A in 2022

Retaining talent, capturing revenue synergies, boosting ESG, and making the most of alternative deal models are top of mind for buyers.

The maturity and urgency of the ESG imperative varies by industry, company, and even by specific deal. As a result, it’s important that companies distinguish between ESG-motivated and ESG-conscious M&A.

ESG-motivated deals are pursued explicitly to advance the buyer’s ESG agenda. Perhaps the most visible examples are in carbon-intensive industries. M&A is a driving force in the energy sector’s transition to renewable sources of power. As we explore in “Energy and Natural Resources M&A: Deals to Deliver the Energy Transition,” incumbents use M&A to reposition their portfolios around sustainable energy alternatives faster than they could be built organically. Meanwhile, in consumer products, the shift from animal- to plant-based proteins has prompted its own surge in M&A and partnerships. For example, to advance its mission of becoming a global leader in plant-based foods, Netherlands-based Upfield acquired leading plant-based cheese manufacturer Arivia. And other consumer goods companies are turning to M&A to address issues important to the social pillar of their ESG strategy. Consider Hershey’s acquisition of health-forward food brand Lily’s or the purchase by Mars of Kind and Ferrero’s acquisition of Eat Natural.

Meanwhile, ESG-conscious M&A incorporates an ESG angle across the M&A value chain, even if the motivating deal thesis is not ESG related. For example, acquirers may perform due diligence to determine if a target’s carbon footprint is aligned with the acquirer’s sustainability goals, unrelated to the deal rationale. Companies seeking transparent and socially conscious supply chains will give extra scrutiny to a potential acquisition’s vendor base. Such ESG-conscious thinking is gaining popularity across industries, though different sectors will place emphasis on different ESG topics.

Our survey of executives found that the mix of deal type varies across industries. For example, while energy sector executives report that the plurality of deals within their industry are ESG motivated, most other industries see ESG-conscious M&A as far more relevant to their current deal makeup (see Figure 1).

Figure 1

To strengthen their ESG efforts in M&A, we recommend buyers ask themselves several key questions that will guide the integration of ESG into the deal-making process.

• Strategy: What are the implications of our corporate ESG agenda on our M&A strategy? How will the board weigh ESG considerations when evaluating deals?
• Diligence: What are the material ESG issues for this deal, and how does the target perform in those areas? What are the potential risks and improvements to our overall ESG position and competitiveness? How do we evolve our diligence playbook to answer these questions? How do ESG considerations impact the value creation plan for this asset?
• Integration: How does ESG factor into our integration thesis? What governance and resourcing is required to ensure ESG objectives and value creation initiatives are met (either for improving the target’s ESG performance or leveraging the target’s strengths to improve our own ESG performance)? What are the specific initiatives to unlock the ESG value creation opportunities?

These questions may be tough to answer, but by asking them early, companies set themselves up to address the ESG imperative for everyone’s benefit as they make the M&A moves that will boost their performance.