Environmental, social, and governance (ESG) criteria are now being adopted as screening factors by many due diligence teams. There can be both downside risks as well as upside value creation with ESG.
Why Conduct Environmental Health, Safety (EHS), and Environmental Social and Governance (ESG) Due Diligence?
When going through a merger or an acquisition, the last thing the buyer wants to worry about is post-acquisition surprises. A due diligence process is meant to characterize a target sufficiently and communicate risks or liabilities that are material to the buyer. During due diligence, a buyer confirms important information about the seller, their finances, contracts, customers, debts, leases, potential lawsuits, etc. The main goal for the buyer is to have a full picture of what they are acquiring with hopes it will match their investment thesis.
What about environmental and safety risks? Buyers may rush through a checklist and not consider EHS due diligence a priority. Unfortunately, if not conducted properly or with the help of an experienced environmental consultant, the due diligence process can come up short. “Coming up short” can be the difference between a successful integration and an extremely costly mistake.
Matt Bell, Senior Consultant of Antea Group’s Environmental Mergers & Acquisitions (M&A) Services, explains, “Due Diligence can be thought of as a sliding scale of investment of time and money versus a return on comfort level. In theory, the more time and money that is invested in the due diligence process, the better the target is characterized, and issues are quantified. Everyone’s perspective and comfort level with risk can be different, so how much time and money that is invested in the due diligence process is up to the buyer.”
Wouldn’t you want to spend the time and money to figure out exactly what you are buying?
Environmental Due Diligence, Not Just a Phase I
When you think of potential EHS risks in the due diligence process, you may only think of subsurface risks. Since the industry standard Phase I ESA focuses only on these risks, as defined by ASTM standard E1527-13, important EHS risk categories are left out. Make no mistake, uncovering potential subsurface risks is an important part of the environmental due diligence process. Subsurface risks consist mostly of soil and groundwater quality issues that could have a major effect on a merger or acquisition, but it is not the only category an EHS professional should evaluate. There are four other categories to keep in mind.
Risks or liabilities associated with infrastructure, operations, and the business entity need to be examined and taken into consideration before an acquisition. Lastly, and equally important given today’s customer and investor-focused business environment, don’t forget about ESG risks as well. An experienced EHS consultant would advise their clients that there is much more to uncover than what is underground.
Infrastructure risks are any contamination issues connected with buildings, utilities, or other structures. For example, contaminated building materials from a former plating operation may affect post-acquisition plans for facility expansion or closing, resulting in costly decommissioning activities. Thinking about these types of factors and how they will affect the post-acquisition business plans is important during due diligence.
Operational risks include compliance issues associated with regulations applicable to an operation. For example, having the appropriate permits and approvals in place, particularly in countries such as China, are important to verify business continuity risks.
Business risks are EHS issues that may be connected with a business entity, but not necessarily connected with an asset or property. For example, a former operating location since divested may carry latent subsurface risks that would not be captured in a standard Phase I ESA for an existing operating facility at a different location. These types of risks are not associated with current assets but rather are connected to the business.
Lastly, ESG in M&A needs to be taken into consideration as well. ESG is a hot topic these days in many business sectors and particularly in the financial marketplace. Why? Because it makes business sense. It would be risky for a company not to think of ESG during an acquisition. Unlike the other risk categories, there can be both downside risks as well as upside value creation with ESG issues depending on the nature of the business.
Talking with our clients, there seem to be three perspectives on the importance of ESG factors and how they may affect their business:
- Clients that have not seriously evaluated it
- Those that have added it to their list of business concerns, primarily driven through stakeholder pressures (i.e., “checking the box”)
- Those that have monetized the value of ESG on their business and adopted ESG as a primary investing tool or a focus to wrap their business plans around
The range of viewpoints and levels of sophistication with adopting ESG factors in their business is quite extraordinary, but for those that have looked at ESG issues and attempted to monetize the effect on the business are consistently finding a material return on investment (ROI). What we see, however, is that the majority have adopted ESG factors in their business only from pressures associated with either their customers, their investors, or more generally social risks to operating their business. Moving from check-the-box adopters to businesses that monetize the issues for an ROI is a big move and involves significant stakeholder involvement both inside and outside the organization, but the value in doing so can be real.
From a mergers and acquisitions standpoint, ESG is now being adopted as a screening factor by many due diligence teams, much like the traditional downside risk screening processes that are used to identify EHS risks to the business. Phase I ESA results are not enough anymore. They often present levels of uncertainty leaving the buyer without a full picture of what is on the table. If the focus is only on one of these categories, you could be missing important EHS risks, liabilities, or even opportunities that would affect the acquisition.
Benefits of Using an Experienced Consultant
EHS consultants can help maximize the value of every transaction. An experienced consultant should find all the potential risk, as well as value-creation opportunities, in every deal so you don’t have any surprises.
When conducting an EHS due diligence process, there are four main things an EHS consult is trying to identify for the buyer:
- Any regulatory obligations that the buyer should be aware of that may entail monetary corrective action
- Risks that may impact the business, tangibly or intangibly
- Help support business decisions that are based on the acquisition
- In the event that risks or issues are identified, advise representatives involved with the negotiations with the seller in order to properly accommodate the risks either contractually or monetarily
EHS and ESG risks don’t need to kill a deal, nor do they need to carry surprises. At Antea Group, we work with our client to understand their investment thesis, evaluate their stakeholders both inside and outside their organization, and characterize the target organization in terms of its own risks, how it will affect our client’s business post-acquisition, and how our client can build value off identified opportunities and/or shortcomings associated with the target business. Our consultants help thoroughly characterize, manage, and mitigate the risks with creative solutions resulting in a successful transition during the M&A integration process.
Contact us today to learn more about how we can support your M&A efforts.
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