How carbon and greenhouse gas emissions are shaping M&A

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Carbon and greenhouse gas emissions are now impacting the price paid for assets in transactions but how are they shaping M&A strategies? Oliver Bridge and Raj Kumar share the essential factors that both buyers and sellers must keep in mind.

Environmental, social, and governance (ESG) considerations have gained substantial traction in the global business landscape in recent years. There's a rise in regulation and we've seen private equity firms launching impact funds, and major banks setting net-zero targets. As businesses across all sectors intensify their efforts in this area, the significance of ESG to stakeholders becomes increasingly apparent.

While the term 'ESG' has faced politicisation and waning momentum, there's a shift towards framing these initiatives in terms of sustainability, emphasising our collective impact on the planet. This shift in focus has given rise to a notable emphasis on environmental factors, particularly emissions and greenhouse gases – and this brings a number of considerations into play for those involved in M&A.

ESG due diligence: Significance of emissions in transactions

Emissions are often overlooked, yet they're having an increasing impact on earnings before interest, tax, depreciation and amortisation (EBITDA) and the overall deal value. This will impact virtually every business, especially those in industries such as manufacturing, consumer goods and healthcare – with a great impact on the more energy-intensive businesses.

The following factors will have a direct influence on the deal's financial value and should be carefully assessed in the due diligence process.

Five areas of ESG due diligence

The availability of green financing options with favourable terms, such as improved interest rates, can significantly influence the financial structure and increase the feasibility of transactions. The rising availability of green loans with favourable terms makes them an appealing option for business debt financing. Emissions performance frequently serves as crucial criteria for green loans. This highlights the importance of having strong assumptions to support emissions performance, ultimately enhancing the likelihood of securing the most favourable loans.

Increasingly, customers and consumers are prioritising environmentally responsible products and services. Businesses involved in transactions need to consider how their environmental performance, including emissions and greenhouse gases, aligns with customer expectations and preferences. Not meeting these requirements can affect your company's brand reputation and market positioning. And this may lead to the inability to service those customers and losing significant revenue. Notably, prominent retailers and organisations, such as the NHS, have escalated their focus in this area, acknowledging the importance of ESG to stakeholders and emphasising the need to safeguard revenue by meeting emissions requirements of customers.

The transition to more sustainable and low-emission operations can involve significant operational and capital expenses (OpEx and CapEx) – often not recognised in financial forecasts. Businesses engaged in transactions should carefully assess the potential costs associated with emissions reduction initiatives, energy-efficient upgrades, or the adoption of cleaner technologies. You need to identify additional costs of any transition plans that aren't included in the forecast of the business, as these can affect the financial valuation of the deal.

Taxation policies and carbon credit mechanisms can directly impact a company's financial performance and profitability. Dealmakers must evaluate the tax implications related to emissions and greenhouse gases – these are heavily influenced by the underlying emissions assumptions. Ensuring these are robust is crucial to ensure accurate payments as excessive emissions could result in overpaying taxes, while underestimating emissions may lead to future tax liabilities. These factors can influence the financial value and feasibility of the transaction.

The presence of emissions-related liabilities and responsibilities can impact carve-out of operations. Assessing how emissions affect your company's financial and operational commitments is critical, as this can have implications for the terms and conditions of the transaction, influencing the overall deal value and structure. When a company acquires a one-third stake in a business, it doesn't automatically inherit a proportional one-third share of the emissions. Some of those emissions are likely to be offset in various ways, which can affect green targets and net-zero objectives. You should consider the existing transition plans of the acquired business and the associated costs these plans involve.

Other ESG considerations for buyers and sellers

Energy costs have been a major concern for businesses, with the volatile energy market leading to significant increases in expenses. Businesses increasingly seek support to navigate the energy markets, optimise energy contracts, and explore alternative energy sources to reduce costs and improve energy resilience. It may be worth considering that various grants and funding schemes are available to support businesses in their efforts to reduce emissions and achieve net-zero targets. Many businesses have opportunities to reduce energy costs, and by not taking advantage of cost reduction and grants, they are missing out on potential savings.

For sellers, it's essential to have comprehensive information on greenhouse gas emissions and carbon credits, and have transition plans readily available. Buyers are increasingly interested in the environmental impact of businesses they're considering acquiring.

The focus primarily revolves around implementing the pre-deal plans, and encompassing cost reduction and emissions strategies. It's equally imperative to ensure compliance, assess stakeholder impacts, and foster understanding regarding the rationale behind the actions taken. Typically, these tasks form part of the post-deal plan, highlighting the importance of integrating emissions and sustainability considerations.

Next steps for businesses involved in transactions  

For sellers, developing a pre-deal plan to identify and optimise energy usage is in order. This will help the business demonstrates it can minimise greenhouse gas output and ensure the business is prepared for a smooth exit.

For buyers, recognising the significance of emissions on deal value is key. You need to identify the associated risks and opportunities through operational and emissions due diligence.

Businesses often seek support in evaluating the value, risks and opportunities within a deal. While some inquire about broader risks and aspects, the primary focus for dealmakers is obtaining the right price and deal structure. It's commonly assumed that compliance considerations can be addressed post-deal, which holds true in most cases. But when structuring the deal, the impact of emissions on the deal's value and price should be a crucial consideration, as it can significantly affect the outcome of the transaction.

Aligning specific projects or actions with validated reductions is essential. Its imperative to assess whether the implemented projects will deliver the promised change and if the invested resources are allocated accurately. Early evaluation is key as significant emissions reductions often require substantial investment, and it's vital to ensure that such investments don't unduly disrupt day-to-day operations. These factors are pivotal considerations in the context of post-deal environmental responsibilities.

For further insight and guidance, get in touch with Oliver Bridge or Raj Kumartracking-pixels

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