Managing Director & Senior Partner; Global Leader of Mergers & Acquisitions
Munich
By Jens Kengelbach, Astrid Latzel, Jana Herfurth, Greg Fischer, Ben Morley, and Roy Huang
Environmental, social, and governance factors are fast becoming key differentiators affecting a company’s future performance. Recognizing this, leading companies and investment firms are erasing the distinction between sustainability and commercial issues when considering M&A and other investments.
This change in perspective has major implications for due diligence. Traditionally, due diligence focused on a narrow set of value-related commercial factors, while sustainability assessments emphasized compliance and risk mitigation. Today, best-in-class corporate and financial investors are integrating sustainability issues into commercial due diligence. Acquirers are exploring the connection between sustainability and value creation throughout the M&A process, and sellers are considering ESG in risk and valuation analyses to enhance their exit strategies.
Effective ESG due diligence requires a robust methodology that considers industry- and region-specific information to estimate and validate the related synergies. By combining a standardized framework with deal-specific deep dives, companies can conduct a comprehensive assessment that lays the groundwork for a discussion of sustainability strategies and potential value creation levers.
Companies and investors have many motivations for integrating sustainability into commercial assessments. For example, customers increasingly factor a company’s sustainability performance into their purchasing decisions. Moreover, transitioning to a greener business model may reduce costs both immediately and over the long term. Although compliance requirements provide some of the impetus, once companies engage more deeply in sustainability topics, they are finding strategic and operational opportunities as well.
There are many new requirements that companies must consider when evaluating acquisitions and other major investments. For example, starting in 2025, the Corporate Sustainability Reporting Directive mandates social and environmental disclosures by large companies with a significant presence in the EU or with securities listed in an EU-regulated market.
Furthermore, two proposed directives from the European Commission have significant implications. The Directive on Green Claims would regulate how companies communicate about their environmental impact and performance, with penalties for noncompliance. In addition, the Corporate Sustainability Due Diligence Directive outlines steps to identify, prevent, mitigate, or eliminate the negative impacts of a company’s operations on people and the environment. The directive includes supply chains within the scope of operations, so companies will need to carefully scrutinize their supplier base.
To create value through sustainability, companies need better data. Public companies are now disclosing sustainability data, often surpassing what regulations require. In private markets, the private equity industry recently launched the ESG Data Convergence Initiative (EDCI) to standardize sustainability data and make it more actionable. The EDCI has made strong progress, offering benchmarks that provide investment firms with first-of-its-kind guidance on how portfolio companies or potential acquisitions perform relative to their peers on sustainability topics. These insights are particularly useful for prioritizing topics for further investigation in due diligence.
Although companies of every size and sector can create commercial value through sustainability, the priorities vary among industries. Some industries, such as steel, cement, chemicals, and airlines, face a particularly pressing need to decarbonize. (See “A Plastics Producer Assesses Sustainable Alternatives.”) However, ESG even affects companies that do not provide physical products or services. (See “A Software Company Explores ESG Risks and Opportunities.”)
An ESG due diligence assessment enabled a plastics producer to identify bioplastics as the optimal sustainable material for its primary applications, considering environmental impact, waste reduction, and resource usage.
Approximately 65% of traditional plastics remain in the environment after one year of being discarded, and approximately 60% remain after five years. The mounting environmental impact is propelling a shift toward more sustainable alternatives. This change has been spurred by escalating consumer and regulatory pressures, sometimes culminating in outright bans.
The plastics producer’s assessment examined the environmental impact of plastics substitutes across its value chain, from upstream production (including feedstock and processing) to downstream end-of-life disposal. The review encompassed traditional plastics, recycled plastics, bioplastics, paper, and other alternatives across applications such as shopping bags, waste bags, agricultural films, food packaging, wrapping, and food service containers.
The assessment found that recycled plastics were best from an environmental perspective. However, they were not suited to the company's core applications owing to technical constraints, such as challenges in recycling film and the quality required for contact with foods.
Paper alternatives are attractive substitutes from a waste reduction standpoint, with approximately 1% of the material remaining in the environment after 100 days. But paper production is associated with higher CO2 emissions (five to seven times more than bioplastics) and increased resource usage (approximately twice the land and more than ten times the water required for bioplastics).
Ultimately, the analysis found that bioplastics would be the preferred alternative for core applications from an environmental perspective. They significantly reduce waste (approximately 7% does not degrade within a year), decrease CO2 emissions (by 25% compared with traditional plastics), and entail limited resource use (up to 95% less land and 90% less water compared with paper).
A software company that provides a logistics platform connecting shippers, carriers, and recipients conducted an outside-in ESG due diligence. The goal was to evaluate the platform’s performance and associated risks, identify how to implement best-in-class standards, and highlight potential sustainability opportunities within the transportation sector. The company intends to use the insights gained to position itself as a leader in sustainable logistics solutions, which would set the stage for divesting the logistics platform.
The assessment encompassed three elements:
Exhibit 1 shows how the materiality of each ESG topic varies across selected industries.
To identify and activate relevant value creation levers, a company needs to determine the ESG factors likely to affect its financial performance, benchmark itself against peers, and prioritize improvement initiatives. A well-designed materiality assessment strikes the right balance between the time and effort expended and the benefits derived. Although comprehensive assessments can be conducted as a standalone project, integrating them into commercial due diligence will have a bigger impact on commercial outcomes. For example, both sustainability and sourcing teams should participate in identifying opportunities to create value by decarbonizing the supply chain.
The standard approach to ESG due diligence consists of three steps that provide a comprehensive perspective on performance and value creation opportunities:
If climate factors are significant for a given investment or divestment, buyers or sellers should expand the standard three-step approach by conducting a detailed analysis of these topics. This may entail developing and assessing an asset-specific decarbonization fact base that encompasses improvement levers, CO2 abatement potential, and possible revenue streams.
Companies can apply the results of their due diligence assessments to identify concrete, granular initiatives and actions, including adjustments to the business plan and implementation roadmap. Exhibit 2 highlights initiatives that companies can take to address a selection of the most pressing ESG topics by industry.
Both buyers and sellers can apply the insights gained from due diligence to more effectively align their strategies with evolving standards and industry-specific sustainability topics, ensuring balanced and informed decisions.
Buy-Side Evaluations Pinpoint Risks and Rewards. Prospective buyers should ensure that they are fully aware of the ESG-related risks and opportunities tied to a potential acquisition target. In the initial stages, they can use publicly available data for a materiality assessment. As the due diligence progresses, they can use the target’s available data to probe more deeply into materiality and evaluate synergies and direct impacts, such as the acquisition’s effects on ESG ratings, risks, or financing requirements. This may entail assessing the acquisition’s impact on the buyer’s own sustainability strategy and transformation needs, including goals for decarbonization or net zero emissions. (See “A Steel Maker Assesses the Challenges of Adopting Emissions-Reducing Technology.”) The assessment should also consider the enablers and a roadmap for harmonizing the parties’ strategy execution. Such an assessment should be carried forward to support the realization of synergies and post-merger integration efforts.
A steel manufacturer was considering the acquisition of another player in its industry. A primary issue was the target’s need to adopt new emissions-reducing technologies to reduce the costs of CO2 emissions certificates. These costs, per tonne of CO2 produced, were projected to more than double between 2022 and 2029.
The acquirer conducted a due diligence assessment to determine the feasibility and financial implications of adopting emissions-reducing technologies:
Sell-Side Assessments Support Valuation. For sellers preparing to divest a business, ESG due diligence can provide essential information for the equity story presented to potential buyers. Sellers should identify whether ESG has a significant up- or downside for the business, as well as investments that could improve performance. They should integrate a sustainability strategy into the sale process, ensuring its alignment with the commercial strategy. The sustainability strategy—whether existing or developed in preparation for a divestiture—should include quantitative data (such as KPIs) and qualitative information that highlights the risks and opportunities for acquirers. If sustainability does not present a significant advantage, sellers should address it on a limited basis in standard due diligence to preempt questions or valuation discounts.
Sustainability is not a compliance checkbox but a crucial consideration for creating value. M&A and investment decisions must therefore consider the integral link between a company's commitment to sustainable practices and its commercial strengths. Buyers and sellers in private equity and the corporate realm need to rigorously assess industry-specific ESG themes and adapt their strategies to the evolving standards. Integrating ESG into the commercial due diligence agenda is crucial to meeting this imperative.
Alumnus