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Why is it time to include ESG in your standard Due Diligence process?

Written by Peter-Jan Roose

Investing in today’s corporate environment is more challenging than ever. Key components such as employee engagement, carbon emissions, and corrupt and fraudulent governance systems create a complexity that can endanger investments.

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To navigate these concerns and mitigate the risks, investors, such as private equities, are increasingly focused on aligning investments with ESG (Environmental, Social, Governance) aspects. A recent Fidelity International study [1] demonstrated that companies with strong ESG strategies are outperforming their non-ESG-focused competitors. Moreover, our CLEAN Framework teaser highlighted that companies have a lower investment and credit risk when they include ESG in their strategy and operations. This means that performing an ESG Due Diligence will help investors and debt providers to trickle down an active ESG mindset to the core of the strategy and operations of their portfolio companies and lenders through various mechanisms (e.g. ESG KPIs for company loans, minimum ESG requirements for investment).

In a more general context, we see that some ESG aspects have become an important part of due diligence processes in recent years, although it has not become mainstream just yet. In addition to the financial, legal, and commercial due diligence of targets, investors focus increasingly on their ESG performance or potential. By comparing two companies that appear to have identical financial and commercial results, a good analysis of ESG criteria can help investors identify risks that would not have been addressed in a traditional due diligence process. Moreover, ESG Due Diligence can have a major impact on the investment lifecycle. A survey performed in 2019 by Capital Dynamics [2] showed that 54% of their survey respondents reduced a bid price based on findings within their ESG Due Diligence, and 32% of their respondents paid a higher price based on the results of the ESG Due Diligence.

ESG is a blind spot

The challenge is to integrate the ESG screening into the due diligence process. When conducting an ESG due diligence, it is important to bear in mind that there is no standard specifying the ESG assessment. The process and standards vary widely from sector and region. In addition to the very short timeframe of a transaction process, and the multitude of factors to consider, it is important to focus on those who are deemed material.

Therefore, BrightWolves designed a 3-by-3 framework that will steer your ESG due diligence and uncover material topics. The 5 building blocks are the following:

  • Main pressures and trends

  • Key stakeholders

  • ESG position

  • Value chain analysis

  • Progress prioritization

1. Uncovering main pressures and trends, where it matters the most

Initially, we will focus our time and energy on identifying the region or market that matter the most to the company. In other words, the market, or region, in which the most revenue and cash is generated globally. We will help you understand the main trends and pressures that come into play there. Through this analysis, we help you to understand the (ESG) elements that will have a material impact on the strategy and operations of the company going forward.

2. Understanding the key stakeholders is crucial

ESG is a broad topic, and to maximize the sustainable value of your investment, you will have to focus your time and resources on the right elements and choose your battles wisely from the start. Therefore, a quick and robust stakeholder analysis is a vital component and allows you to understand and respond to legitimate concerns.

We will identify, map and prioritize the stakeholders and include a high-level overview of their main concerns. With this approach, you will be able to understand the current status properly and have the key information and elements to focus on going forward.

3. Comparing its current ESG position

Finding your way in the alphabet soup and digging deeper into the company’s position, versus its main competitors, can be complex. Nevertheless, it is important to have a general understanding of how it compares to industry standards and norms, global corporate sustainability reporting and practices. Resulting in a general overview of the current situation in the market, while likely uncovering areas in which the target leads or lags.

4. Value Chain analysis

By leveraging our data and experience, we support you in discovering the areas of your company’s value chain that have the biggest potential for improvement. We will investigate and visualize the company’s value chain in our 3-by-3 framework, focusing on the inbound, own operations, and outbound flows. In each area, we will analyse the biggest drivers of ESG impact and perform baseline measurements where needed.

We will not stop with the standard scope 1, 2, and 3 GHG emissions overview, but will also investigate the company’s performance on resource use, climate change vulnerability, human rights, biodiversity impact and upcoming regulations impacting that specific area of the value chain, amongst others.

Wouldn’t you want to know about the risks disrupting the entire value chain before they occur?

5. Prioritization to navigate growth with impact

We could stop here and write up a beautiful report with all the information and data gathered in the 4 steps mentioned above, but we consistently aim to have maximum impact in everything we do.

All the information and data points gathered during the entire analysis, are of considerable value for all involved in the process. That is why we decided to end with a few additional overviews that summarize the analysis and areas to tackle first. Additionally, we will share the specific datasets used throughout the analysis, the baseline calculations performed, and metrics deemed interesting to track over time. These impact metrics will help you to maximize the positive impact of your investment and support navigating its growth.

And when the time comes, this report can act as a baseline quantifying your impact creation between acquisition and exit.

Interested to know more?


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