Felipe Barreto Veiga
BVA - Barreto Veiga Advogados, São Paulo
felipe@bvalaw.com.br

Gabriel Abdalla
BVA - Barreto Veiga Advogados, São Paulo
gabriel@bvalaw.com.br

Introduction

The due diligence process is a crucial step in M&A and investment transactions. In recent years, it has become increasingly common for due diligence procedures to take longer, leading to extended timelines for closing transactions. Although it is in the opposite direction to society's practices, which seek to optimise and reduce the time spent on any activity, considering the new cultural aspects and technologies, the due diligence procedure in M&A transactions has gone through almost unnoted transformations, expanding the scope and, mainly, the depth of the associated investigations, according to numerous M&A executives and due diligence firms.^[1]

As cultures and customs rapidly evolve, there is a need to revisit and ensure greater prominence for some subjects. Matters that were previously seen as accessories are beginning to have a relevant impact on worldwide transactions. This means that the corporate world is now focused on issues that used to be optional, but are now mandatory.

Environmental, social and governance (ESG)

One of the main reasons that may explain why the due diligence process is taking longer is that the scope and depth of the investigations has expanded. In the past, due diligence used to focus mainly on financial and legal matters. However, ESG issues have become increasingly important, for instance. It is a reality that is still being shaped and is gaining relevant space in the corporate world, leading to a greater need to delve deeper into these issues during due diligence, as they can significantly affect the success or failure of a transaction.

It is relevant to point out that the issues mentioned, which are constantly evolving as their relevance becomes evident, have always been present in the due diligence performed in the past. What we are experiencing in recent years, however, is a greater need to go deeper into these issues, considering that all players are looking into these matters and that these issues are becoming more and more present in the pricing of a transaction and within the regulations themselves around the world.

In the United States, for instance, the Securities and Exchange Commission (SEC) has ESG-related disclosure proposals currently pending, addressing environmental issues, which may mark the beginning of more demanding ESG reporting requirements. In 2023, the SEC plans to introduce more proposals covering human capital management and board diversity issues, which means that companies will have to devote considerable time and resources to adjusting and creating adequate oversight and internal controls.^[2]

In this way, some consequences of the lack of an ESG policy may not be discernible to the naked eye, so the subject remains overlooked. The abstention from these practices or procedures that seek to ensure compliance with these topics, to ensure more rational and quicker processes, may eventually cost a lot.

The elements for consideration

Although it may take longer to close potential transactions, as ESG policies become integrated into the day-to-day activities of companies, the relevant information regarding ESG aspects will become more organised and rooted in the professional's agenda, making any clarifications or data related to the topic more accessible and assertive.

Furthermore, it is crucial to contextualise the applicability of any new policies to delimit the analysis during the transaction and assess how these themes are handled within an organisational structure. This consideration should include the particularities and maturity of the company, whether it is in an early stage or is already consolidated. The depth of the analysis depends on many factors and should not be neglected. On the other hand, the limits of the proceedings must be clear, considering the knowledge of the executives and the activities developed by the company.

With the maturing of these themes, the new generation of companies and startups must already integrate this mindset at the company's foundation so that the resulting analyses and investigations become part of the company's routine procedures, and any non-compliance with the precepts they disseminate will have an increasing impact. This means the solution to avoid possible delays arising from new proceedings lies in a default ESG policy, as a premise for all the proceedings regarding the company's activities since its formation.

Thus, it is essential to understand the target business and delimit the scope of due diligence so that it follows market needs, taking into consideration the maturity level of the target company to anticipate any eventual delays resulting from new regulations and practices. This procedure is crucial to guarantee that all the relevant information that may bring risk to the transaction is investigated without such analysis causing unnecessary bureaucracy and wasting time.

Avoiding unnecessary delays

Despite the challenges arising from this matter, it is possible to anticipate and avoid delays both on the buyer and seller side. By taking the steps below, companies can help to reverse the trend of longer due diligence procedures and ensure they are prepared to address ESG-related risks and opportunities in M&A and investment transactions:

• Anticipate and prepare: Before a potential merger and acquisition or investment transaction, companies can reduce the time of the investigation into ESG issues by developing a default ESG policy as a premise for all proceedings related to the company's activities. Such a policy can help to ensure compliance with ESG regulations and avoid delays resulting from any new practices.
• Embrace ESG policies: If a company never had an ESG policy, it can integrate a policy into its day-to-day activities to make relevant information more accessible and assertive. Such a policy can help to reduce the time needed to clarify or document ESG-related topics.
• Stay up to date with regulations: Companies should stay up to date with regulations related to ESG issues, such as the SEC's proposals concerning human capital management and board diversity, to ensure that they are ready to adjust their internal controls and oversight.
• Delimit the scope: From the buyer side, it is possible to delimit the scope of due diligence based on the maturity level of the target company to ensure that all the relevant information is audited, without unnecessarily adding bureaucracy or wasting time.
• Sale and purchase agreements (SPA): Considering the findings of the due diligence, it is possible to indicate in the SPA representations and warranties the ESG matters, without prejudice, to apply a timeline regarding actions that should be taken by the seller, to solve or remediate possible contingencies regarding the ESG agenda. Such an addition may ensure that these measures will be checked after the signing of the final transaction documents and may result in a more streamlined due diligence process.

Conclusion

Only with the maturing of ideas, as well as the standards and procedures expected for the fulfilment of these matters, will agility be ensured, both in the investigative proceedings and in any remediation to be executed by the target company.

In conclusion, we note that the world has been going through numerous changes and evolutions, thus investigative procedures such as due diligence need to adapt to all new concepts. This may result in complex proceedings and more time needed to close a transaction. Besides, such adaptation needs to be carefully put into practice to guarantee both the celerity of the proceedings and the safety of the execution of the final documents of the operation. It is important to emphasise that these new practices are welcome and need to reflect the changing desires and challenges faced by society. Human sciences and the law are not immutable and need to be in continuous evolution to fit the new world's needs.

Sources:

www.legalbusiness.co.uk/co-publishing/sponsored-briefing-the-impact-of-esg-on-ma-transactions/

www2.deloitte.com/ce/en/pages/real-estate/articles/ESG-due-diligence-on-the-rise.html

www.consultancy-me.com/news/5662/esg-due-diligence-on-the-rise-in-the-mergers-acquisitions-scene

https://corpgov.law.harvard.edu/2020/02/20/the-coming-impact-of-esg-on-ma/

www.corpgov.law.harvard.edu/2023/02/06/esg-in-2023-politics-and-polemics

www.allens.com.au/insights-news/insights/2021/11/the-growing-importance-of-esg-due-diligence/