ESG ‘increasingly decisive’ in private equity purchases

Many businesses have halted mergers and acquisitions because of their target companies’ poor ESG performance, a new report reveals.

And the study, commissioned by the UN-backed Principles for Responsible Investment Initiative (PRI), showed that even if a deal goes through, buyers increasingly use poor ESG performance to leverage a lower purchase price.

The study was conducted by consultancy PwC to assess attitudes among trade buyers of private equity companies to ESG opportunities and risks in mergers and acquisitions.

Two-thirds of buying companies said substandard ESG performance had ended or dampened their interest in reaching a deal, while good ESG practice boosted their enthusiasm to buy, with a third believing such a purchase would enhance their reputation and brand.  

Part of the disincentive to buy poor ESG performers is the perceived high cost of standardising management controls, policies, procedures and operating systems.  

PwC focused on ESG integration into due diligence processes, including price, sale and purchase agreements, and post-acquisition activities. The interviewers surveyed 16 corporate buyers in various sectors, most of which operate globally and are headquartered in Europe, the US or Canada.

Most of the companies, which include Alliance Boots, Centrica, EDF and Xstrata, have made up to three acquisitions in the past two years, with many of the target companies located in the US, Brazil, China, India and Russia.

Most of those interviewed told PwC that ESG performance has become an increasingly important factor in mergers and acquisitions, a trend they expect to continue for at least the next three years.

Most buyer companies said they considered their general sustainability approach to be ‘quite advanced’, but a significant number realised their ESG due diligence performance was ‘less well developed’. However, there is a general trend towards greater standardisation and formalisation of the process, led by more centralisation and co-ordination by trade buyers. The extent of ESG incorporation into due diligence varies according to business sector and the size and location of a deal.

PRI executive director James Gifford concluded: “This report shows why ESG considerations should be a fundamental part of any private equity deal-making process. The PRI has seen growing interest from private equity companies in ESG issues and now counts over 150 general partners and more than 130 limited partners as signatories.

“The recent decision by private equity group Cerberus Capital Management to sell its investment in gun manufacturer Freedom Group, following the tragic Sandy Hook School shootings in the US, underscores the increasing influence of limited partners and the growing materiality of ESG issues on investment risk, return and reputation.”