In the high-stakes world of mergers and acquisitions (M&A), the focus has long been on traditional synergy metrics. Reducing costs through operational efficiencies, increasing revenue by capturing new markets, and optimizing financial structures for tax benefits have long been the cornerstones of successful M&A strategies. However, as the world sets down the path of achieving the ambitious targets of having net zero emissions by 2050 and limiting temperature rise to 1.5 degrees above pre-industrial levels (both already considered unrealistic by some), it becomes imperative for the private sector to update its legacy practices and catch up as well.
Over the last decade, environmental and social factors have significantly influenced regulatory landscapes, consumer behavior, and investor decisions. A 2023 EY study states that 90% of international investors look for a company’s sustainability performance as a key metric for long-term business resilience, while a study by Capgemini found that 79% of consumers are changing their preferences based on ecological and community impact. This has led to another type of synergy gaining prominence in M&A: sustainability synergy. With climate change being a looming existential threat for many businesses and their supply chains, the sustainability perspective must not be ignored. However, with numerous environmental and social variables affecting business operations, the challenge is identifying key topics. How does one determine the most important issues for a target business and assess their fit with the acquirer? And how can a target business enhance its sustainability position to achieve a higher valuation and become more attractive to potential acquirers?
A wonderful tool that can enable companies to identify and leverage sustainability synergies is Double Materiality, introduced by the European Commission in 2019 in the guidelines for the Non-Financial Reporting Directive, and further refined by the Corporate Sustainability Reporting Directive (CSRD) in 2022. The term ‘materiality’ refers to the threshold at which information becomes relevant enough to influence the decisions of stakeholders, like investors, regulators, or consumers. ‘Material’ topics are those issues that can substantially affect an organization's ability to create, preserve, or erode economic, environmental, and social value for itself and its stakeholders.
Double Materiality Assessment (DMA) incorporates two perspectives: financial materiality and impact materiality. Financial materiality examines how climate and social issues impact a company’s bottom line—think regulatory changes, resource scarcity, and shifting consumer preferences. On the other hand, impact materiality looks at how a company’s operations affect the world around it, from carbon emissions to water usage and supply chain practices. Although DMA has primarily been used in corporate sustainability reporting, it can also be applied to the M&A process to offer a more holistic approach by providing a comprehensive view of potential risks and opportunities.
Pre-Merger Due Diligence:
During the due diligence phase of an acquisition, sustainability synergies can be found by incorporating a DMA, which includes assessing Impact, Risk, and Opportunities (IROs) of sustainability topics and subtopics. While conducting a DMA, topics such as climate change,
human rights, and corporate governance are broken down into subtopics like carbon footprint, resource usage, and community impact.
Stakeholders of the target company will then be asked to rate the subtopics from both impact materiality and financial materiality perspectives. For impact materiality, they will assess the subtopics based on the scale, scope, and irremediability of impact. For financial materiality, they will evaluate the magnitude and likelihood of financial effect. Based on these ratings, we identify which topics are material and then conduct an IRO assessment of all material subtopics.
Furthermore, evaluating the target's supply chain sustainability can reveal risks and opportunities that may not be immediately apparent. A thorough analysis of the supply chain can uncover potential issues related to labor practices, sourcing, and the environmental impact of operations. This evaluation can lead to the development of action plans to address any concerns and improve the sustainability profile of the supply chain.
Once the subtopics have been rated, they are prioritized based on their materiality, and IRO assessments are conducted for each:
● Impact Assessment can evaluate how the target company’s environmental practices, such as energy use and waste management, affect its financial performance (financial materiality) and the broader environment (impact materiality). For example, a high carbon footprint might pose regulatory risks and contribute to climate change, impacting both the company’s financial stability and its environmental footprint.
● Risk Analysis can identify potential environmental risks associated with the target company’s operations, like liabilities from current or future regulations, supply chain disruptions, etc., and assess the likelihood and severity of these risks to understand their potential impact on the acquisition.
● Opportunities Identification can look for situations where the target company’s environmental practices can be leveraged for value creation. This might involve adopting renewable energy initiatives, enhancing energy efficiency, or capitalizing on a strong environmental brand reputation. For instance, if the target company has a robust renewable energy program, this could be expanded post-acquisition to reduce overall energy costs and carbon footprint.
Developing a materiality matrix (graphical representation of the DMA) at this stage aids in prioritizing key issues based on their potential impact and stakeholder importance. This groundwork not only informs negotiations but also sets the stage for a smoother integration.
Negotiations Phase
During the negotiation phase, insights from the double materiality analysis and materiality matrix play a crucial role. Addressing identified risks and opportunities in negotiations and evaluating the target's compliance with environmental regulations and its overall sustainability strategy can help mitigate future liabilities and enhance deal value. Such
insights can influence the valuation of the target, as companies with strong sustainability practices may command a premium.
Considering broader market and industry trends in climate change can guide the negotiation process. Awareness of regulatory changes, emerging standards, and shifting consumer preferences helps forecast the future environmental and regulatory landscape and positions the company accordingly. This foresight is crucial for ensuring that the acquisition not only meets current standards but also remains resilient to future developments. Incorporating these insights into the negotiation phase allows acquirers to make informed decisions that contribute to sustainable value creation.
When negotiating, it is advisable to include contractual safeguards that address identified sustainability risks. This can include earmarking funds for potential environmental liabilities and incorporating clauses that mandate specific sustainability practices post-acquisition.
Post-Merger Integration Phase
Post-merger integration (PMI) is where sustainability synergies can be fully realized. The DMA can help in aligning the practices of both companies, ensuring a cohesive approach to environmental management.
A comprehensive PMI strategy incorporates sustainability objectives alongside traditional financial and operational goals. This plan should align the material topics and subtopics identified during due diligence with the strategic goals of the combined entity. For instance, if waste reduction was identified as a key subtopic, specific targets and timelines for waste reduction initiatives should be set. This ensures that sustainability is embedded into the core strategy of the newly formed organization, driving both environmental and financial performance.
Moreover, actively leveraging synergies between the merging companies can significantly enhance sustainability outcomes and drive competitive advantage. Identifying and utilizing these synergies might involve sharing best practices or combining resources for larger-scale green initiatives.
Governance and accountability are crucial for the successful implementation of green initiatives. Establishing governance structures, such as setting up sustainability committees and appointing responsible executives, is essential. Additionally, integrating triple bottom line (profit, people, planet) metrics into performance reviews ensures that environmental ambitions are taken seriously at all levels of the organization. Regular monitoring and reporting on progress towards these milestones maintain transparency and accountability, helping the organization stay on track and make necessary adjustments in a timely manner.
Engaging with key stakeholders through transparent communication fosters trust and cooperation. Implementing feedback mechanisms such as surveys, workshops, and regular updates helps maintain an open dialogue, addressing any concerns or suggestions. This inclusive approach ensures the effective implementation and long-term success of the sustainability vision.
Strategic Advantages of Sustainable M&A
One of the primary benefits of including the climate and social perspective in M&A is enhanced risk management. Sustainability risks can pose significant threats to long-term value. Environmental liabilities, such as potential cleanup costs or compliance with stringent new regulations, can drastically alter the financial outlook of a deal. Similarly, poor social practices can lead to reputational damage, consumer boycotts, or workforce disruptions. By thoroughly evaluating these risks, companies can make more informed decisions, potentially avoiding costly pitfalls.
Beyond risk management, sustainable M&A can also open the door to substantial value creation. Companies that excel in eco-friendly performance often enjoy stronger brand loyalty, access to new markets, and preferential treatment from regulators and investors. Identifying and leveraging the target company’s strengths in these areas can enhance the combined entity’s overall value proposition.
As the priorities of the human species undergo a paradigm shift, integrating sustainability synergies into M&A has become essential in today's business environment. It guarantees thorough risk assessment, uncovers new pathways for value creation, and aligns with the increasing emphasis on sustainable and responsible business practices. Given the rising importance of sustainability, double materiality—and emerging concepts like triple materiality—stand poised to become indispensable tools for companies navigating the complexities of mergers and acquisitions. Embracing these frameworks will not only enhance the resilience and attractiveness of businesses but also contribute to a more sustainable and responsible global economy.
