Four ways ESG is reshaping M&A

ESG considerations in M&A

Environmental, social, and governance (ESG) factors are redefining value and risk in business. Growing concerns over climate, sustainability, diversity and inclusion, pay equity, and more are increasingly shaping public policy—and public opinion. Businesses are starting to consider investments and activities in a new light. That includes Mergers & Acquisitions (M&A).

The value of ESG in M&A is undervalued

As in many evolving fields, ESG planning appears to lag behind awareness. Teams responsible for M&A strategy and deal-making are starting to recognize ESG’s significance: Nearly 70% of those Deloitte surveyed considered ESG of high strategic importance in M&A.1 However, they’re not always clear how to act on that insight. Forty-three percent said they include ESG in M&A discussions only occasionally, rarely, or very rarely—and 39% lack clearly defined metrics for evaluating ESG.

M&A professionals are still learning how to navigate the new ESG landscape and all its uncertainties. They can start by understanding how to respond to the four key ways in which ESG is reshaping M&A:

  1. ESG opens up new pathways to value.

    Some may take a narrow view and characterize ESG considerations as simply new risks to navigate. That view is only half correct. The more important side of ESG may be the significant opportunities it affords to create new value.

    Private investors reaped record value from ESG in 2021. Eighty exits by companies in fields like climate tech, clean tech, and impact investing returned $86 billion in aggregate to investors, according to analysis by Deloitte and Pitchbook.2 And studies have shown that better ESG performance correlates with higher annual returns by as much as 3.8%, leading to a compound effect of 20% to 45% over five to 10 years.3 One life sciences company boosted Earnings Before Interest, Taxes, and Amortization (EBITDA) by 10% by building an anerobic digester to convert bio waste from third parties and its own operations into energy—and revenue.

    Businesses seeking to improve their ESG performance are also driving up the valuations of organizations that build their offerings around core ESG issues. Such businesses are in low supply compared to current demand. As a result, ESG-focused companies may enjoy premium valuations. Renewable energy providers averaged valuation to EBITDA multiples of 15.2x in M&A deals between 2019 and 2021, compared to 6.1x–12.8x for traditional oil and gas companies.

  2. ESG requires a broader understanding of risk.

    Looking at a business through an ESG lens can reveal more than new value-creating opportunities. It can also uncover potential new risks—including some that deal teams may have little experience with. These may include physical risks related to climate change’s expected impact on sea levels and weather systems, as well as risks stemming from the global transition away from fossil fuels. 

    These can raise important questions: Will climate change put assets like infrastructure, real estate, or cropland at risk from rising sea levels or extreme weather events? What future regulations may make compliance more costly or challenging for certain assets? Could new climate tech innovations introduce low-carbon alternatives that disrupt markets and supply chains? 

  3. ESG impacts can be quantified in dollars. 

    Part of the challenge in understanding ESG value and risk has been that some organizations may not know how to translate these issues into dollars. That makes it difficult to account for them in valuations and investment strategies. There’s been notable progress in this area, though. We have advised a variety of clients on the quantitative value of ESG issues, helping them better understand their financial impacts. 

    In one case, a buyer walked from a potential deal to acquire an energy provider that had greenwashed its revenue reporting. Achieving the target’s stated revenue mix of 80% tied to renewable fuels would have required a $300 million investment. 

    New tools and techniques can also help quantify ESG impacts. Private equity firms have been proactive in this area. For instance, several private equity investors banded together with the nonprofit Accounting for Sustainability to publish the Essential guide to valuations and climate change, a comprehensive framework for quantifying climate-related risks and incorporating them into valuations.

  4. ESG requires longer-term planning.

    Some ESG risks will play out over many years, if not decades—far longer than the typical three- to five-year time horizons M&A models use. This heightens exit risk for firms, given that they have limited visibility into how emerging regulations, technologies, or risks may affect a business over the long term. Governments in some geographies are starting to set aggressive emissions targets to reach net-zero in the coming decades. Future regulations could dramatically affect value in multiple ways. Demand for certain assets, such as those tied to fossil fuels, could fall precipitously as businesses shed them from their portfolios. Compliance costs could also rise for certain industries to stay in line with net-zero mandates. 

    These same circumstances can significantly boost value, too, as markets emerge for low-carbon alternatives like green hydrogen. 

    Going forward, valuation models should consider longer time horizons. It might help to analyze scenarios at planned exit for private equity or in five to 10 years for a strategic deal. It will also be crucial to account for the full range of ESG factors beyond just climate change, including DEI, ethical procurement, scarcity of resources, and more.

M&A can give organizations and practitioners a unique position to help drive positive impacts for people, business, and the planet.

They should act now on this opportunity to help make a meaningful difference in some of today’s most important issues and reap the potential benefits from spearheading ESG progress.

Four ways ESG is reshaping M&A

End notes:

1 Deloitte and PitchBook, Road to next, 2022. 

2 Five largest ESG funds in 2021 listed by MSCI. Sources for three-year returns: Yahoo! Finance, Morningstar.

3Cole Horton and Simon Jessop, “Positive ESG performance improves returns globally, research shows,” Reuters, July 28, 2022; Tensie Whelan et al., ESG and financial performance: Uncovering the relationship by aggregating evidence form 1,000 plus studies published between 2015–2020, NYU Stern Center for Sustainable Business and Rockefeller Asset Management, 2021.

4 Accounting for Sustainability (A4S), Essential guide to valuations and climate change, accessed May 2023.