A new expert talk from Refinitiv explores the growing need for due diligence relating to ESG to be incorporated into pre-deal analysis in the private equity space.
- Robust due diligence can help investors to identify a range of potential risks before concluding any PE deal – and ESG-related due diligence is becoming increasingly important.
- Conducting broader due diligence research and adopting additional risk mitigation measures are also essential.
- Due diligence is an ongoing process and partnering with a trusted, specialist due diligence expert can add immediate value.
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PE deals and the need for ESG due diligence
Potential PE acquisitions and investments – which involve illiquid, private or unlisted companies and assets – must be thoroughly researched and analysed prior to concluding any deal.
This is the message of a new expert talk from Refinitiv, which underscores the critical importance of comprehensively evaluating any potential risks that could be linked to a PE investment. The core challenge in any PE deal is maximising profitability, and therefore mitigating risk is of paramount importance.
This is where thorough and robust due diligence, which can help investors to identify a range of potential risks, becomes invaluable.
Our expert talk goes on to stress that, in addition to risks such as those relating to financial or IT concerns, ESG risk factors must also be considered, as ESG legislation and directives continue to gain traction across the globe.
Two pertinent examples include:
- The German Supply Chain Due Diligence Act (SCDDA), which has been in force since January 2023. The act regulates corporate responsibility around issues such as (but not limited to) human rights and environmental standards – and crucially extends due diligence responsibilities to cover a firm’s contractual partners and other indirect suppliers and subcontractors.
- The EU Commission’s Corporate Sustainability Reporting Directive (CSRD), also effective January 2023, which requires companies to report on how their business activities impact people and the environment and how sustainability impacts their organisations.
The consequences of non-compliance with these and other relevant regulations can be significant and can extend to potentially substantial fines and reputational damage.
Ensuring that any new acquisition or investment complies with ESG-related regulations and will not inadvertently introduce risk to the PE fund, is therefore key.
Best practice insights
Our expert talk offers a range of practical insights into how to develop a best practice response to the need for ESG due diligence.
Companies need to ensure that they acquire a holistic understanding of the ESG-related policies and practices of any target company before concluding any deal.
It is worth assessing a target company’s waste management initiatives, energy use, pollution control, treatment of animals and conservation efforts, to name a few.
Factors to consider include supplier relationship management, whether there is support for local community initiatives, whether employees have safe and healthy working conditions, and more.
PE funds should ensure, for example, that a target company maintains transparency in their accounting and promotes the participation of shareholders. They should also seek to understand how the target deals with conflicts of interest and other challenges.
In addition to the critical importance of gathering ESG-related information such as this, conducting broader due diligence research is also essential. This research should include, inter alia:
- Screening and further research where areas of concern are identified
- Official corporation registry checks
- An analysis of ownership and UBO records
- Media checks for any adverse media
- Litigation and regulatory checks
- Reputational enquiries
Broader risk mitigation that extends beyond due diligence includes such considerations as:
- Detailed risk analysis on the prospective target and their direct and indirect suppliers
- Formulating, establishing and adopting policy statements post-acquisition
- Developing comprehensive remediation procedures
- Formalising complaints procedures and clearly documenting findings
Finding the right due diligence partner
When considering any acquisition or investment – including those that fall under the PE umbrella – many companies find that the volumes of information that must be analysed and assessed can be overwhelming – and partnering with a trusted, specialist due diligence expert can be a valuable exercise.
Not only does using external specialists ensure independence and objectivity, but it also can help verify any information collected by the investor.
A trusted due diligence partner should not only have access to world-class data, but also offer global coverage and regional, on-the-ground insights to further inform better investment decisions.
Our expert talk goes on to stress the importance of remembering that due diligence is an ongoing process that requires reliable access to accurate, up-to-date information.
The key takeaway is this: due diligence – including that relating to ESG considerations – has a crucial role to play in any potential PE acquisition or investment decision.
Read the full expert talk here.