How do ESG criteria affect corporate transactions?
We observe that institutional investors are increasingly assessing companies with an increased focus on ESG compliance. The background to this is often the ever-increasing demands of the financiers behind the investors (insurance companies, banks, pension funds, etc.). This is because they are increasingly demanding compliance with corresponding criteria due to the growing awareness of ESG in society as well. Both in the context of due diligence and in the context of contract drafting, the challenge here is that a specific (market) standard does not yet exist in this area. Nevertheless, various criteria have already emerged that have a positive or negative impact on financing and/or company valuation.
ESG influences the execution of the entire transaction from due diligence to closing and beyond. At the beginning of each transaction, we first assess with our clients which ESG criteria are relevant to them based on the target company’s business model and the requirements they have set themselves, and what weighting is assigned to each of them. The ESG request list we have designed is then adapted to the criteria we have identified.
Subsequently, the information provided on the basis of our questions is incorporated into our Legal Due Diligence Report and provides our client with concrete advice on how to deal with the “findings”. Our recommendations for action refer to the specific formulation of the purchase agreement, the shareholder agreement or to-do’s post-closing. For example, we are increasingly adding warranties, indemnities, earn-out clauses, or even MAC clauses related to ESG risks to purchase agreements. In some cases, we also work with closing conditions that stipulate, for example, that certain standards are implemented prior to closing to establish ESG compliance of the target company.
Since, in our experience, this is often not feasible in the short time between signing and closing, it is not uncommon for shareholders’ agreements to include a commitment to integrate ESG criteria into the company’s own processes and to define guidelines and standards after the transaction. In addition to the usual reporting obligations of the target company towards the investor, there are now corresponding ESG reporting obligations. What the ESG reporting obligations look like in concrete terms is usually worked out in ESG workshops together with the investor and external consultants immediately post-closing. The focus here is in particular on reporting on emission reductions, equal pay and equal representation on supervisory bodies.
Corporate governance that is guided by ESG criteria has a variety of advantages. Such entrepreneurs, on the one hand, have more potential prospects who want to invest in or acquire their business. This is because a large number of investors are placing an increasing focus on investing in ESG-compliant companies for political, economic or reputational reasons. On the other hand, this often increases the value of the company, which usually leads to an increase in the purchase price. Furthermore, the consideration of ESG criteria reduces the effort of buyers as well as sellers in the context of a transaction, which also reduces transaction costs.
Since the implementation of ESG guidelines and standards is not done “overnight”, we advise our clients on the seller side to deal with this topic at an early stage. Many companies are currently facing succession challenges and a sale is often the only option. In this case, addressing ESG issues upstream of the sales process is recommended (e.g., as part of vendor due diligence). We provide support in identifying ESG criteria, implementing them in the company and presenting the documentation in order to optimize the subsequent sales process.
About Christoph O. Breithaupt
Christoph O. Breithaupt is a founding partner of SKYE PARTNERS and advises in particular buy-out transactions for private equity funds, entrepreneurs and investment companies (both on the buyer and seller side). He also advises corporate M&A clients on domestic and international transactions, including acquisitions, divestitures, joint ventures and restructurings. Before founding SKYE PARTNERS, he worked for almost ten years at major international law firms.