Strategic ESG Considerations: Shaping M&A Transactions in India

Take a close look at ESG Considerations that drive sustainable and responsible business practices, shaping the landscape of corporate transactions.

Brief Introduction

In today's business landscape, the spotlight on Environmental, Social and Governance (ESG) issues is booming as this trend holds particular significance in the context of M&A (Mergers and Acquisitions) transactions in India. From the initial stages of negotiation to post-closing considerations, ESG factors turn out to be an integral part.

This article explores the impact of ESG on due diligence, the integration of findings into agreements, and the relevance of these considerations for both public and private companies. By voluntarily embracing ESG norms, companies cannot only align with legal requirements but also enhance their appeal to investors, customers, and employees.

ESG Issues in M&A

There is a notable surge in investor and customer enthusiasm regarding environmental, social, and governance (ESG) issues, leading to the widespread incorporation of this term in everyday business discourse. The significance of ESG matters persists on a global scale, and this holds for M&A transactions in India as well.

Right from the inception of the M&A transaction throughout the due diligence process during the negotiation of the transaction documents up to closing and even post-closing, the ESG issues continue to be very much relevant in a minute transaction. ESG issues assume a lot of significance in an Indian M&A context.

Investors are increasingly favourably looking at companies who are ESG compliant and therefore if a company is ESG compliant whether in terms of having robust anti-corruption policies, anti-money laundering policies, employee policies being environmentally sound, etc., the chances of attracting good investors at great valuation is very high.

For instance, a manufacturing company which has poor environmental policies is vulnerable to a fire hazard which can cause accidents in the factory or if having poor money laundering policies or anti-corruption policies, it is hard to attract good investors at a decent valuation.

Customers are also increasingly looking to do business with companies who are ESG compliant and therefore if a company is ESG compliant it gives you a significant competitive advantage. Even employees are looking to stick around with companies who are pro-employed in the outlook and policies and therefore to attract and retain top talent, So, a company will be well advised to be an ESG company and have employee policies.

Influence of ESG on Due Diligence Outcomes

When conducting due diligence in an M&A deal with a focus on ESG, there are important considerations. First off, it's crucial to create a specialized checklist for the diligence process tailored to the industry and operations of the target company. It's recommended to have this checklist reviewed and crafted by an ESG expert to ensure a targeted approach during the ESG diligence.

Another key aspect is scrutinizing claims made by the target regarding ESG compliance to avoid instances of "greenwashing" — where a company boasts about its sustainability efforts but falls short in practice. Moreover, the diligence process shouldn't be limited to reviewing documents; on-site visits are important.

These visits can uncover issues like oil spillage that may not be evident from paperwork alone. Also, the focus on ESG diligence may extend the overall transaction timeline. Investors should consider this when negotiating the terms of the deal, including the term sheet and exclusivity period. Factoring in this additional time ensures thorough and meaningful ESG diligence without unnecessary haste.

Integration in Definitive Agreements

After evaluating ESG issues during the due diligence stage, the next step is to weave these findings into the final agreements. This involves tailoring your assurances, guarantees, and safeguards to encompass these discoveries and address any risks that can be managed through contractual measures.

For example, we might create a distinct indemnity to handle a particular non-compliance issue or choose to treat anti-corruption and anti-money laundering warranties separately. Adding an extended indemnity, emphasized in uppercase, provides an extra layer of protection. By doing so, we enhance our insulation within the agreement, ensuring a more robust alignment of contractual safeguards with the specific ESG considerations uncovered during due diligence. This approach facilitates a more comprehensive and targeted risk mitigation strategy in the final agreements.

The other key factor is if we have constructs like earn-out and their contingent payouts and if there is a critical warranty being breached like anti-corruption, then reserve the right to suspend or terminate those payouts if those issues turn out to be true. If there are material issues from diligence around ESG try and look at this transaction structurally and holistically if it needs to be amended for instance introducing a holdback to appropriately mitigate the risks.

Relevance to Public and Private Companies

ESG rules are important for all types of companies, whether they're listed (on the stock exchange) or not. For listed companies, the rules are a bit stricter. For example, SEBI (the market regulator) makes the top 1000 listed companies give a detailed report called the Business Responsibility and Sustainability Report (BRSR). It's like a big overview of how the company is doing in terms of business responsibility and sustainability.

Insofar as public and private companies are considered all other companies, we have to comply with several laws which fall in the ESG bracket, for instance, certain companies who have to comply with the corporate social responsibility norms under the Companies Act 2013, of course, there are sort of environmental laws and labour laws which has to be complied with and other laws in connection with money laundering and anti-corruption.

That's why companies must follow these rules. Even if some rules are not mandatory, it's good for a company to follow them voluntarily as investors and customers appreciate companies that willingly adopt these standards. So, it's a smart move for a company to adhere to these norms, even if they aren't strictly required in some cases. It not only keeps the company in good standing with the law but also makes it more attractive to investors and customers who value responsible business practices.

Conclusion

ESG assumes a lot of significance in the Indian M&A context. Customers, investors, and employees, all want to be associated with companies that are ESG compliant and therefore it's very important to get a competitive advantage to attract good investors with great valuations.

When it comes to checking things thoroughly, it's crucial during due diligence not to limit ourselves to a simple review. We must customize the list of requests based on the size and nature of the company's business. Also, we must keep an eye out for problems like oil spills and false claims about being environmentally friendly (greenwashing).

Take the extra time needed to conduct a comprehensive ESG due diligence, ensuring a meaningful and holistic examination of environmental, social, and governance aspects. As the diligence is complete, we transform those findings into definitive agreements appropriately so that we have a reasonably well-briefed risk allocation package as a buyer.

Also, when it comes to the ESG regime it applies not only to publicly listed companies but also to private companies and unlisted public companies. Therefore care should be taken to adhere to this and even voluntarily given the whole outlook of investors customers employees is better to voluntarily be compliant with this norm.

References

[1] The Value of ESG in M & A, Available Here