Environmental, social, and governance (ESG) themes have become a critical component of today’s M&A transactions in Australia and globally. According to industry experts, this trend is likely to persist in the foreseeable future.
If your organization is gearing up for an M&A deal where you expect ESG to play a crucial role, conducting a materiality assessment can increase the chances of a successful transaction.
Read on to find out what materiality assessments are, why they matter in the current ESG-conscious M&A landscape, and how to conduct one successfully.
What is a Materiality Assessment?
Materiality assessment is the process of engaging the stakeholders of an organization (both internal and external) to identify, affirm, and prioritize the ESG issues that are most critical to them and the organization.
Once completed, the organization uses the insight gained from materiality assessment to create meaningful ESG targets and practices and to inform its strategic planning and sustainability reporting.
Why is ESG a Crucial Factor in Today’s M&A Transactions?
According to a survey by Baker Tilly International, 83% of dealmakers said they conduct due diligence on ESG issues in investments and M&A. Furthermore, a staggering 60% reported they’ve abandoned investment opportunities due to a negative assessment of ESG issues in potential targets.
The main reason for the increased emphasis on ESG in M&A, according to experts, is a growing realization among businesses and investors that ESG is a critical driver of long-term value creation.
Specifically, experts suggest that a strong ESG proposition can create value in the following ways:
1. Revenue Growth
The modern consumer market highly values sustainability. For example, one recent study showed that one in two Australians actively seek out greener products and services. In this increasingly sustainability-conscious market, a strong ESG proposition can help reinforce a company’s brand positioning and increase its market share, resulting in revenue growth.
2. Cost Efficiencies
Companies that perform well on ESG issues tend to enjoy cost efficiencies through lower energy consumption, reduced waste and emissions, lower employee turnover, easier talent attraction, and higher productivity.
3. Legal and Regulatory Landscape
ESG-driven companies are proactive in responding to anticipated legal and regulatory changes. This proactive stance puts them in a good position to access government support and subsidies while also opening pathways for innovation.
4. Capital Expenditure Optimization
A strong ESG strategy can enhance returns by allocating capital to more promising, sustainable assets and investments. It can also help companies stay away from investments that might not pay off in the long term because of future environmental issues.
5. Lower Costs of Capital
Companies that demonstrate clear commitments to ESG or manage ESG risks efficiently are typically well-positioned to access sustainable financing, such as sustainable loans, whose costs are tied to specific ESG targets. Meeting these ESG targets enables companies to access financing at competitive rates.
What’s more, by demonstrating stronger ESG credentials, companies can unlock new capital opportunities from the rising global pool of ESG-conscious investors.
How Can an ESG Materiality Assessment Empower M&A?
Conducting an ESG materiality assessment prior to an M&A transaction can provide numerous benefits to your firm.
1. It Can Help You Identify and Address Material ESG Risks
A materiality assessment can help pinpoint potential ESG risks that could adversely impact an M&A deal’s success. By proactively addressing these risks before you go to the negotiating table, you can boost the odds of a successful transaction significantly.
2. It Can Help Increase the Value of the Deal
A materiality assessment can reveal new ESG opportunities, such as cost savings via sustainable practices or new revenue streams from innovative products or products. Pursuing these opportunities, or at the very least laying the necessary groundwork for their pursuit, can enhance your long-term growth prospects in the eyes of M&A partners. This can position you for a potentially higher valuation.
At the same time, addressing any ESG risks identified by the materiality assessment — such as regulatory non-compliance — can prevent potential M&A partners from undervaluing your firm. Interested partners can undervalue a firm if they think its existing ESG risks will lead to liabilities, such as lawsuits, in the future.
3. It Can Promote Greater Transparency
Carrying out a materiality assessment demonstrates a commitment to transparency and proactive management of ESG risks and opportunities. This can help build trust or credibility with potential partners and make you a more attractive M&A target.
4. It Can Streamline the Due Diligence Process
Firms that are considering entering into an M&A deal with you will evaluate your ESG strategy as part of their due diligence.
Insights gained from a materiality assessment can help you present a more comprehensive and clearer picture of your ESG strategy or proposition to potential partners. This not only saves them valuable time and resources that would otherwise be spent on an extensive due diligence process but also mitigates the risk of deal-related delays or complications.
Key Steps in Conducting an Effective Materiality Assessment
Follow these steps to perform a buttoned-up materiality assessment for your firm.
1. Define Scope and Purpose
Start by defining the goals or objectives of the materiality assessment. Determine what materiality means for your business, the key audience for the materiality assessment outcomes, and what you plan to do with the results.
2. Identify Stakeholders
It’s crucial to engage as many stakeholders as is reasonably possible to ensure a variety of opinions are heard. Identify the internal and external stakeholders from whom you will collect insights and opinions.
Potential stakeholders can include employees, suppliers, customers, board members, shareholders, institutional investors, government regulators, business partners, trade unions, the media, and the community where you operate.
3. Identify Material Topics
Review sources, including media reports, internal data, external peer reviews, sector-specific regulations, and wider social and environmental trends or challenges, to create a list of potential material topics that are most relevant to your business.
4. Prioritize Topics
Refine your list of material topics so that you’re left with the most important or relevant topics for your business or industry. For example, the top management could come up with a methodology for scoring each topic. Those with the lowest scores are put aside, while those with higher scores move forward.
5. Design Your Materiality Survey
Decide how you’re going to collect the insights of stakeholders. A traditional survey, whereby you ask the relevant stakeholder to rate the importance and impact of each ESG topic listed on a scale of, say, 1 to 10, is often the simplest approach. Make sure to provide room for stakeholders to leave additional comments or insights.
You’ll also need to decide the medium through which to conduct the survey. Try to use one that’s easily accessible and simple to use. Online survey software such as Google Forms or SurveyMonkey are good options to consider.
6. Launch the Survey and Collect Insights
Reach out to the relevant stakeholders and direct them to the medium you chose in the previous step to collect their insight. Be sure to include a deadline for the survey to encourage timely responses. Additionally, remember to express gratitude by including a thank you note after the survey is complete.
7. Analyze Results
Once the survey period has ended, review the results of each ESG topic or issue to determine those that are most important to each group of stakeholders.
The next step after this review is to map the results using a materiality matrix. A materiality matrix presents the importance of ESG issues to your firm graphically in two dimensions:
- The horizontal x-axis represents the importance/materiality of ESG issues to your organization in terms of their expected influence on its success.
- The x-axis represents the materiality of issues to stakeholders
The stronger the materiality of an ESG issue for the company, the further it slides to the right of the x-axis. The more relevant it is to stakeholders, the further up the y-axis it moves.
Here’s an example of a materiality matrix:
8. Put Insights Into Action
The final step is putting your materiality assessment findings into action. Start by sharing the findings (that you’ve now assembled into a materiality matrix) with stakeholders and welcome additional feedback.
Use the insight to accomplish the purpose you defined in Step 1, e.g. to shape your sustainability/ESG reporting or for strategic planning.
How CapLinked Can Support ESG-Conscious M&A Deals
A virtual data room (VDR) like CapLinked can be quite useful when it comes to sharing information — such as ESG data from materiality assessments — securely and efficiently during the due diligence phase of an M&A.
With enterprise-grade security and advanced features like granular user permissions and detailed tracking, CapLinked can help you keep your sensitive data secure while giving you the flexibility to collaborate with potential partners.
Contact Caplinked today to learn more about how we can support your M&A activities.
Sean LaPointe is a freelance writer with experience in finance. He has previously written for
several well-known brands and publications, including The Motley Fool and
PWC Australia – Why ESG is Core to Private Equity’s value creation agenda
McKinsey & Company – Five ways that ESG creates value
Baker Tilly International – Deal breakers and opportunity makers: The role of ESG in M&A
Fahrer and Co – ESG considerations in private company M&A transactions