Research: environmental, social and governance factors as crucial as P&L in M&A due diligence

Research into value creation and risk in mergers and acquisitions (M&A) has found that environmental, social and governance (ESG) considerations are now just as important as the financials, in the context of M&A due diligence.

Researchers from leading global professional services firm, Aon plc, interviewed experts from corporates and private equity firms, as well as professional advisers, who highlighted three aspects of due diligence that have become increasingly important over recent years: the prominence of ESG considerations; digital technology; and new dynamics in public markets.

Aon has called for a new approach to M&A due diligence and the report sets out strategies for dealmakers to tackle each of these factors.

Alistair Lester, global co-CEO of M&A and transaction solutions at Aon, commented: “Gone are the days of solely focusing on the P&L, cash flow and balance sheet to understand deal value – this report shows that traditional approaches to due diligence are no longer enough”.

He added: “Today, sellers and buyers must assess a business’ ESG practices, digital capabilities, technology and intellectual property just as closely as they scrutinise financials. Expert insight alongside public and client-specific data is necessary to help quantify and value assets, identify and mitigate risks and ensure proper disclosure.” 

The report acknowledges that ESG risks are difficult to measure and quantify and urges parties to approach ESG due diligence with the same level of consideration as financial due diligence.

To avoid ESG targets being treated simply as an abstract concept within the due diligence process, Aon suggests business embed these targets within the business, as they would financial targets – “Adoption of taxonomies and regional directives that support sustainable investments, such as climate-based thresholds, are a big step forward in shaping the evolution of ESG diligence”. 

According to the World Economic Forum, digitally enabled business models are set to account for 70 per cent of new value in the global economy in the next decade. The report explores the buyer focus required on digital assets and capabilities of the target businesses. It says obtaining a thorough analysis of the technology stack, digital KPIs and cyber risks is critical to determine and achieve business forecasts, as bidders assess whether to acquire a business. 

The research also highlights the importance of understanding digital performance in the context of the potential for scale. Scrutiny of the target's existing infrastructure including servers, cloud footprint and use of open-source technologies, is key.

Aon warns that a recent surge in SPAC activity presents new risks for deal participants. It also flags that activist shareholders are on the rise in areas such as ESG, which may impact management buy or sell decisions. The report seeks to support dealmakers in navigate this complex landscape.