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The role of ESG factors in shaping M&A deal value and reputation
Kocián Šolc Balaštík, Prague
The role of ESG factors in shaping M&A deal value and reputation
Environmental, social, and governance (ESG) factors and human rights considerations are increasingly shaping the landscape of mergers and acquisitions (M&A) deals worldwide. The growing importance of these factors stems from heightened investor scrutiny, evolving regulation and an increased awareness of the commercial risks and opportunities associated with ESG and human rights issues. ESG and human rights factors have the potential to influence M&A deal value and corporate reputation, highlighting the importance of an ESG focus on due diligence, integration and disclosure throughout the transaction process.
ESG and human rights frameworks
Several international frameworks and guidelines shape the understanding and management of ESG and human rights issues in business. Key frameworks include the United Nations Guiding Principles on Business and Human Rights (UNGPs), the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises, and the comprehensive legislative approach being implemented by the European Union – which includes, inter alia, the EU’s draft directive on corporate sustainability due diligence (CSDDD) and the expanding scope of the EU’s Corporate Sustainability Reporting Directive (CSRD) and its accompanying technical standards.
Companies that fall within the scope of these new regulatory environments will need to identify and take steps to mitigate or prevent resultant adverse ESG impacts on their business operations and within supply chains. However, perhaps in contrast to other more traditional ‘legal frameworks’, the importance and value being placed on ESG factors within international business today means that even those companies that may not yet be directly impacted by ESG directives or regulations may, from a commercial perspective, find themselves having to nevertheless undergo ESG assessment and reporting to meet the demands of not only global business partners, but also customers, employees and stakeholders.
ESG and human rights impact on deal value
Numerous studies suggest a positive relationship between strong ESG performance and long-term financial performance. As a result, investors are increasingly using ESG factors to assess potential targets, impacting purchase prices and deal terms. Companies with robust ESG and human rights records may command higher valuations and more favourable deal terms, while those with weak records may face challenges in attracting investors or securing advantageous terms.
Post-acquisition, effectively integrating ESG and human rights factors can create value by reducing risks, enhancing operational efficiency and improving stakeholder relations. Conversely, failure to address these issues has the potential to lead to financial losses, reputational damage and legal liabilities.
Reputational risks and opportunities in M&A transactions
Corporate reputation is a crucial asset in M&A transactions. ESG and human rights issues can significantly impact a company’s reputation, affecting its attractiveness to investors, customers and other stakeholders. Equally, purchasing a target company with a robust ESG track record and ratings may serve to help the purchaser burnish its own ESG standing. Increasingly, high-profile M&A deals face intensified public scrutiny and potential backlash due to concerns about environmental degradation, human rights abuses (particularly in regard to employment conditions in underdeveloped countries) or poor corporate governance.
Engaging with stakeholders – investors, employees, customers and local communities – is essential for managing reputational risks associated with ESG and human rights issues. Companies that successfully address these risks can enhance their reputation, strengthening their competitive position and creating long-term value.
The nature of ESG due diligence
ESG due diligence differs from traditional industry-specific due diligence conducted by environmental consultants or other non-legal professionals. While ESG compliance is sometimes addressed by technical non-legal industry experts, analysis of ESG impact from a transactional and legal risk perspective is closely intertwined with legal matters such as corporate governance, disclosure requirements and human rights. Lawyers play a crucial role in analysing the legal implications of these factors, addressing potential financial, reputational and risk liabilities, and assessing impact and compliance with the growing body of applicable laws and regulations.
The ESG due diligence process undertaken by lawyers of a potential target will seek to establish a risk profile and analyse risk exposure. Potential topics may include:
- Regulatory compliance: assessing the target company’s compliance with relevant ESG laws, regulations and industry standards, such as environmental permits, labour laws and anti-corruption regulations;
- Material risks and opportunities: identifying and evaluating the material ESG risks and opportunities associated with the target company and the proposed transaction, including potential liabilities, reputational risks and value creation opportunities;
- Contractual provisions: incorporating ESG-related representations, warranties, covenants and indemnities in the transaction documents to allocate risks and responsibilities between the parties;
- Disclosure requirements: ensuring that the target company’s ESG disclosures comply with applicable legal requirements and best practices, and advising on potential risks associated with ESG-related communication and reporting; and
- Post-acquisition integration: assisting with the integration of ESG and human rights factors into the combined entity’s policies, management systems and governance structures, and advising on post-acquisition compliance and monitoring.
Incorporating ESG factors into M&A transaction documents
Drafting and negotiating contractual provisions that specifically address ESG factors is essential for addressing the responsibilities and obligations concerning ESG risks in a transactional setting. Examples include the following.
Representations and warranties
ESG-specific representations and warranties can be tailored to address material compliance with ESG laws and regulations, the effectiveness of ESG policies and management systems and the accuracy of ESG reporting. For example, a buyer may require the seller to represent and warrant that the target company has implemented a human rights/ESG due diligence process in line with the various EU directives or UNGPs, or that it complies with applicable climate-related disclosure regulations.
ESG-related covenants can obligate parties to maintain or enhance ESG performance, implement ESG initiatives or engage with stakeholders. A buyer might require the seller to commit to a post-closing environmental remediation plan or to establish a robust supply chain management system that addresses social risks, such as forced labour, within a specified timeframe.
ESG indemnities can protect the buyer from unforeseen liabilities related to ESG matters, such as environmental contamination or corporate governance failures. A buyer might seek indemnification for any losses arising from non-compliance with ESG laws, regulations or standards that are discovered during the due diligence process or that materialise post-closing.
Purchase price adjustments
ESG performance or risks can be factored into purchase price adjustment mechanisms, incentivising strong ESG performance. For example, the parties may agree to link a portion of the purchase price to the achievement of specific ESG milestones, such as reducing greenhouse gas emissions, improving worker safety or enhancing board diversity.
Conditions precedent or subsequent
ESG factors can be integrated into conditions precedent or subsequent to ensure that material ESG risks and opportunities are addressed before or after the transaction. For example, a buyer may require the target company to obtain a third-party ESG assessment or to remediate identified environmental risks as a condition precedent to closing, or to develop and implement a post-closing ESG integration plan as a condition subsequent. Post-acquisition monitoring and improvement is also key in order to maintain or improve ESG performance, addressing any gaps and engaging with stakeholders to demonstrate commitment and progress.
Some best practices for ESG and human rights disclosure in M&A transactions
- Provide clear and concise information on the material ESG and human rights risks and opportunities associated with the transaction, supported by relevant data and performance indicators;
- Discuss the due diligence process, including the methodologies and criteria used to assess ESG and human rights factors, and outline the steps taken to address identified risks and opportunities;
- Describe the integration plan and post-acquisition actions, including any planned investments, initiatives or governance changes aimed at improving ESG and human rights performance;
- Engage with stakeholders – investors, employees, customers and local communities – to gather feedback, address concerns, and demonstrate commitment to ESG and human rights issues; and
- Companies should also be mindful of the challenges and risks associated the potential for greenwashing or reputational backlash if disclosures are perceived as incomplete, misleading or inconsistent with actual performance.
The growing significance of ESG and human rights factors in shaping M&A deal value and reputation underscores the need for a comprehensive approach to specific due diligence, integration and disclosure. By understanding and addressing these factors throughout the transaction process, companies can enhance their reputation, reduce risks and create long-term value for stakeholders. The role of lawyers in this process is critical not only in terms of ESG regulation but also in terms of contractual guidance to reflect industry standards and expectations in driving change, as companies seek to adopt more responsible and transparent approaches to ESG and human rights management in M&A transactions.
 Guiding Principles on Business and Human Rights (United Nations Human Rights Office of the High Commissioner, 2011), see www.ohchr.org/documents/publications/guidingprinciplesbusinesshr_en.pdf.
 Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937) (Eur-LEX), see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52022PC0071&qid=1682338640643, accessed 8 May 2023.
 Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting (Text with EEA relevance) (Eur-LEX), see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32022L2464, accessed 8 May 2023.
 Maria Montenegro, ‘How ESG drives corporate financial performance’ (Wolters Kluwer, 20 February 2023), see www.wolterskluwer.com/en/expert-insights/the-importance-of-esg-as-a-key-drive-of-corporate-performance.