Implementation

Pre-acquisition due diligence can help investors to understand the ESG performance of a target and identify potential material ESG risks and opportunities, which could impact the business case or business value.

1. Target Sourcing/Deal Origination – organisations can screen proposed acquisitions against material ESG factors – things to consider include:

• Ensure alignment of the target company with a firm’s values and principles (e.g., consider specific exclusions, potential LP, or other sensitivities).
• To align with internal and key stakeholders' ESG-related policies, there may be a requirement to consider the development of specific exclusion lists for certain sectors and geographies (e.g., fossil fuels, and animal testing).
• Evaluate inherent sector and geographical ESG risks, using ESG sector/geographical briefing notes for investment teams or other tools. Some firms align later stages of due diligence with initial risk ratings (e.g. internal policy may indicate that “low” inherent risk businesses require no further ESG action during due diligence whereas “moderate” or “high” risk businesses may require further due diligence).
• Consider ESG risks and opportunities in light of the entire value chain of the business/sector.

2. Due Diligence (DD) – is the point to identify and investigate any past, current or future material ESG risks and can help investors to understand the ESG performance of a target which could impact the business case or business value. The findings of the due diligence often inform the ESG focus during the holding period. Points to consider include:

• Consider the nature, location, and activities of the target company (as well as the time and budget available) to inform the scope of the due diligence exercise.
• Consider ESG risks and opportunities across the whole value chain.
• Consider legacy and future material ESG issues.
• Review compliance against current and future ESG regulation risks.
• Allow sufficient time and access for due diligence. Unless preferable to start earlier, ESG consultants are typically commissioned at the “exclusivity” stage when expenditure can be justified to complete the transaction and where specialist knowledge is required.
• Allocate a team member responsible for ESG due diligence or consider training all investors to recognise ESG-related risks and opportunities.
• Share lessons learnt (e.g., material issues) across investment teams and apply them to sector guidance notes.
• Include material ESG issues in the Sales Purchase Agreement (SPA), to ensure commitment by the portfolio company.

The steps a GP can take to incorporate ESG into its ownership practices and engagement with management.

Portfolio Management:

Conversations with the portfolio company regarding which ESG topics should be material, including those identified during due diligence, should be the focus once the acquisition is done and discussed during the onboarding process.

The actions required to manage ESG topics during ownership will vary depending on whether the portfolio company is a pre-existing asset or newly acquired, and the level of priority the portfolio company has given to ESG historically.

While some companies will have managed ESG issues effectively for some time, others may be less advanced. The GP will need to work with management to balance the portfolio companies’ ESG objectives with the rest of the team’s responsibilities.

Measures that can be put in place within the portfolio company include:

• Implementing an ESG policy or strategy;
• Assigning resources and responsibilities, and setting up processes to implement the ESG policy or strategy;
• Making the portfolio company’s board accountable for ESG performance;
• Embedding ESG-oriented objectives into corporate KPIs;
• Linking ESG remuneration to ESG performance on material KPIs and regular reporting;
• Organising meetings with representatives from all portfolio companies to share knowledge on ESG topics; and
• Establishing an ESG data collation and reporting framework.