Environmental and social credentials will be a driver of agency M&A activity. Nick Berry writes in The Drum

5th September 2022

The times we live in will be remembered for many things – a pandemic, war in Europe, 1970s-style inflation, a revolving door being installed at 10 Downing Street – but the rise of environmental and social awareness will not become a memory. The manner in which governments, business and individuals balance short-term economic pressures with long-term sustainability and social justice is arguably the most important challenge for our and future generations.

We are seeing more people becoming vocal and active across mainstream politics, as well as other forms of disruptive protest to create awareness and drive change. But while specific industries are now clearly marked as targets for the damage they cause, businesses across all sectors are having the spotlight shone on them as never before.

Greenpeace’s protests aimed at WPP at this year’s Cannes Lions was both surprising and innovative in equal measure. WPP agencies won two Gold Lions for work with Greenpeace, but this didn’t stop the campaign group from using guerrilla marketing tactics to storm its private beach at Cannes to highlight its dealings with fossil fuel companies.

Whether or not these protests work in the short or even medium-term is not the point. No agency – or client for that matter – can afford to brush off these events and think they are immune from being targeted. Business needs to understand that consumers are getting wise to greenwashing, so brands and their agencies can no longer make performative gestures. ESG (environmental, social and governance) standards must be top of mind for agencies and their clients moving forward.

In the past, ESG efforts were primarily viewed as good PR to receive favorable media coverage, please socially conscious employees and mitigate risk. Things have moved on since then: ESG considerations are increasingly viewed through the lens of value creation. Just as high and transparent ESG standards will help brands engage with their consumers and help agencies become more attractive to clients, both existing and prospective, with my Green Square M&A hat on I am certain they will also make agencies that are looking to sell appear much more attractive to potential buyers.

Following on from the Cannes protest, Silvia Pastorelli from Greenpeace said: “We have nothing against the creative sector. There is a lot of incredible energy and talent, but we would like to see that used as a force for good.”

I speak to entrepreneurs all the time and ESG is high on their agenda. Privately-owned businesses across the marketing and creative sectors often have a strong social conscience and have motivated and committed staff that echo the thoughts of Pastorelli. It is genuinely important to them and the cultures they are creating that positive ESG is part of their DNA. This will uphold their values, help them differentiate from the competition, help them attract the best talent and the most prestigious clients. It will also inform their M&A strategy when the time is right to attract the right buyer.

With ESG issues near the top of the agenda for governments and the public at large all over the globe, it is now a tangible factor for private equity houses and institutional investors. It is consequently a driver for transactions – in the form of both disposals of risky assets (for example, fossil fuels) and acquisitions of sustainable assets or assets that will help a company achieve its ESG goals (such as renewables, recycling, waste management, tech and aquaculture), as well as B2C transactions. At the same time, ESG factors are receiving more attention in due diligence and deal terms as their materiality increases. And on a purely practical level, there’s also greater regulatory focus on ESG – reflected in the introduction of reporting requirements across the globe (including in the UK, Japan, Hong Kong and China) and moves in Europe to impose new corporate governance and risk management obligations.

While reporting requirements have, to date, largely been targeted at publicly listed companies, they are expected to be extended to large private companies in many jurisdictions. It is important, therefore, in the context of private M&A to consider how ESG risks and regulations may affect a company’s reporting obligations, or any plans to exit an investment in the future, through a subsequent disposal or an IPO.

An interesting development in recent years has been the rise of B Corp, a non-profit network that seeks to certificate businesses on their environmental commitments, good corporate governance and transparency. The rapid growth in businesses becoming B Corp-certified demonstrates the commitment of many businesses trying to do the right thing and reflect wider societal views. The ongoing benefits of certification are becoming clearer for all kinds of companies: attracting and retaining staff in the midst of a global talent war, attracting new business and winning public favour.

There are now thousands of B Corp-certified companies. A random search using the keyword ’advertising’ reveals that there are almost 300 agencies listed on the B Corp website. But ESG is still often overlooked as a lever you can pull to grow value from M&A activity. It does not replace the importance of Ebitda and a strong management team etc, but it can make your enterprise more attractive.

There may be acquirers concerned as to whether they can uphold the standards expected of being a B Corp if they take over a certified company. In time, however, the increasing need for larger businesses to prove that their actions speak louder than words should mean savvy acquirers will seek targets to improve their own cultural and commercial commitments and social perception in the market.

It was not so long ago that sustainable investment was confined to a small dedicated corner of the PE market. It’s now moving into the mainstream. Sustainability is permeating almost every aspect of private markets. Private equity firms are now integrating ESG considerations across the investment cycle – proven by the fact one in three general [PE] partners have now hired sustainability officers, which is almost double the number from two years ago. Those that that fall behind are likely to face pressure from limited partners and lenders to up their game.

In M&A, negative ESG issues – whether related to environmental impact, board diversity, supply chain management or other factors – may affect deal certainty by impacting target valuations in previously unexpected ways. They may also affect the availability of financing for a transaction as lenders and investors increase their focus on these issues.

’ESG due diligence’ is becoming more important for corporate and private equity buyers in M&A transactions. Buyers and advisers need to be savvy in diligence exercises, particularly as monetary or other traditional ’risk’ thresholds may prevent discovery of some ESG issues, such as human rights breaches in the supply chain.

Deal protection provisions are another area in which ESG is impacting on M&A transactions. Buyers may request ESG-related warranties above and beyond the traditional scope of ’compliance with law’ warranties. ESG-specific warranties need careful consideration to ensure risk is balanced and any breaches are objectively identifiable. This is especially important if the parties want to utilise warranty and indemnity (W&I) insurance for the transaction.

Sellers may also want to protect their reputation post-closing by conducting diligence on the buyer or seeking post-closing commitments as to how the business will be run by the buyer in future to maintain ESG standards.

At Green Square, we have been increasingly focussing on sellers’ ESG credentials, as well as their numbers, as part of our assessment and support in preparing our clients for acquisition; this is because we believe that good practice, governance and being proactive in upholding sustainability will create greater value over time. Entrepreneurs need to take note!

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