Interview with Florian Bornhauser, Senior Manager and Due Diligence Expert at KPMG Switzerland.

Florian Bornhauser

Florian Bornhauser

Florian Bornhauser, you are the lead author of KPMG's international study on ESG due diligence in M&A transactions (KPMG EMA ESG Due Diligence Study 2022). What was the aim of the study and what were the key findings?

The objective of our study was to provide clarity on the current best practice of integrating ESG concepts into the M&A process. This is against the backdrop that sustainability has increasingly becoming a critical factor in the strategy of many companies, both from a regulatory and business perspective. From experience we know that the practices of investors on the topic differ significantly, so we surveyed over 150 active investors across the EMEA region. The key findings from the survey are threefold.  First, the issue is indeed on investors' minds; second, investors are increasingly willing to pay a premium for more sustainable companies; and third, there is a growing consensus on what "good" ESG due diligence looks like.

According to your study, 40% of acquiring companies in the EMEA region already integrate ESG aspects into the due diligence of M&A transactions. Why?

Correct. Those companies that already conduct structured ESG due diligence as part of a merger or acquisition usually do so because they recognize its financial value. They understand that ESG factors can significantly impact deals. For example, it is better to identify a potential ESG risk early and be able to react accordingly during the pre-signing phase. Our study showed that investors who regularly conduct ESG due diligence are significantly more likely to identify ESG risks in a timely manner. This has often led to tangible consequences, be it a reduction in valuation, a contractual hedge or, in very serious cases, even the termination of the deal.

So, this is an extension of the previous scope of the audit to minimize risk.

Yes and no. There are indeed some risks associated with ESG factors that are looked at more seriously today than in the past. At the same time, there are also more and more investors who no longer focus "only" on the risks, but have recognized the potential value creation of ESG. These investors often see positive ESG performance as an indicator of professional corporate governance. Furthermore, they actively look for operational improvement opportunities related to sustainability, which is then reflected in the financial value of the acquisition target. In other words, they believe that good ESG management has a direct impact on the value of a company and use ESG due diligence to substantiate this hypothesis.

Are investors really willing to pay more for sustainable companies?

According to our study: Yes, about half of the investors surveyed said they would be willing to pay a sustainability premium of 1% to 5% if the target company had a positive sustainability profile. In addition, there was even a small but significant minority of 15% of respondents who would pay 5% to 10% more and about 3% of respondents who would even consider a premium of more than 10% if ESG criteria are met. Conversely, investors who are not prepared to pay more for a more sustainable company are clearly in the minority at around one third.

Why are there some companies that do not yet conduct ESG due diligence?

The biggest challenge here for many companies is the sheer breadth of ESG issues, as depending on how they are interpreted, they can affect virtually all areas of a company. In principle, ESG can cover many different issues - be it climate and decarbonization, child labor, conflict minerals, diversity  and inclusion, anti-corruption and many more. Accordingly, many investors find it difficult to choose a pragmatic and targeted due diligence approach that focuses on the "right" areas.

In addition, data related to the seller can often be relatively scarce, and the quantification of possible findings can present investors with practical challenges when conducting ESG due diligence.

Basically, the share of investors who have not conducted ESG due diligence in the past is already in the minority and will continue to rapidly decline. So the question is not so much why some companies are not yet conducting ESG due diligence, but rather how those investors who are now in the process of developing their ESG due diligence approach can do so most effectively.

What is your advice to companies that want to conduct ESG related due diligence?

To mitigate the complexity created by the breadth of the ESG concepts, investors should first and foremost understand their own company's ESG strategy and identify the areas that are important to them. It is also important to ask whether there are other ESG areas that could potentially be relevant, depending on the type of transaction being considered. Together these considerations will help to determine the scope of work involved to conduct ESG due diligence.

We have also observed that investors who are advanced in ESG due diligence not only consider the risks, but also screen target companies, particularly for value creation potential, to identify commercial and operational improvement opportunities. Furthermore, the most advanced investors also link the findings of their ESG due diligence directly to the respective post-signing action plan for the acquired company.

In this respect, it could be particularly exciting for many industrial companies to follow the practices of international financial investors who due to regulation, have been forced in recent years to actively incorporate ESG into their investment process and are thus often already one step ahead.

What does this mean for corporate sellers?

The issue is also highly relevant for sellers. If buyers are increasingly paying attention to the issue of ESG, it means that sellers need be well prepared for the sales process.

We expect that in the near future, sellers will no longer be able to avoid clearly articulating the role of ESG factors in their equity story. They will need to be prepared to credibly demonstrate this and back it up with data during the subsequent due diligence. If they don't, they will face increasing difficulties, for example in the form of a lower sales price or a more problematic due diligence process.

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