With increasing pressure from laws and regulations imposed by the UN climate summit in Paris, sustainability is becoming increasingly important in business.
One of the goals of the Paris Climate Agreement is set out in the "Green Deal," which encourages businesses to disclose the extent to which their activities contribute to European ambitions.
Recently, the climate summit in Egypt took the next step. On Sunday, Nov. 20, 2022, a final agreement was reached on the creation of a global damage fund for countries vulnerable to the effects of climate change. In return, a number of parties, including the European Union, do want countries to take additional steps to prevent further warming. For example, it was agreed that countries have until the end of 2023 to adjust their climate targets to meet the Paris Climate Agreement's commitments.
This broader focus on ESG factors - Environmental, Social & Governance - presents opportunities for dealmakers as the era of "easy money" comes to an end.
Cheap money
The era of "easy money" has ended after a long period. Cheap money and low inflation created a favorable environment for corporate transactions. These incentives are beginning to wane as inflation skyrockets and political leaders recognize the need for balancing the books.
As dealmakers, we have to accept that the opportunities created by so-called "free money" will disappear fairly quickly, but other opportunities will present themselves under the impetus of new laws and regulations regarding ESG.
In March 2021, Europe introduced new regulations for the financial sector: the Sustainable Finance Disclosure Regulation (SDFR). The SDFR focuses on the sustainable, social and environmental changes and concerns rules on transparency, such as providing sustainability-related information related to financial products. With increased public scrutiny of ESG practices of private companies, those businesses with weak qualifications can no longer hide.
In addition to the many obligations imposed by the SDFR, the increasing focus on ESG factors also provides opportunities.
Value creation
Bain & Company research shows that ESG is one of the starting points for value creation today. In the private equity sphere, ESG has become standard due to the growing realization that value creation and sustainability can go hand in hand. Being at the forefront of the global movement toward sustainability and advanced ESG integration is necessary to achieve competitive advantage.
PwC s report called "Private equity's ESG journey" shows that private equity businesses can be game changers if they make ESG central to their business strategy. At the same time, those private equity businesses that do not embrace ESG will risk significant value erosion. The key lies in the approach to ESG: bridging compliance to sustainable value creation.
This value creation is also reflected in acquisition candidates.
Free cash flows
For acquisition candidates, it is important that they remain focused on their ESG policies in the macroeconomic environments. Corporate sustainability increases free cash flows by generating higher revenue.
Besides the increase in free cash flows, having a sustainable ESG policy leads to a lower risk profile. The company is better and faster able to adapt and comply with rapidly changing laws and regulations. In addition, the company is often more successful in recruiting and retaining suitable personnel, which can have a substantial impact given the tight labor market.
The increased free cash flows and lower risk profile result in value creation of the company. The importance of ESG policies and increasing pressure from new laws and regulations ensures that sustainability is seen as a new mantra now that the era of "easy money" has ended.
