We were inspired to discuss ESG-driven due diligence failures on mergers & acquisitions based on Mark Segal’s August 7th article in ESG Today, Over Half of M&A Dealmakers Have Cancelled Deals on ESG Due Diligence Findings: KPMG Survey, (thank you for sharing Mohamed Amer, Ph.D.). 

Our perspective on the increase of M&A deals canceling based on ESG (Environmental, Social, Governance) due diligence failures is driven based on several reasons:

1.    Risk Mitigation: ESG factors can pose significant risks to businesses, including legal, reputational, operational, and financial risks. Deal cancellations reflect a proactive approach to risk mitigation. If a target company has ESG issues that could lead to future liabilities, negative public perception, or regulatory non-compliance, acquirers might choose to cancel the deal to avoid inheriting those risks.

2.    Reputation and Stakeholder Pressure: In today’s interconnected world, a company’s reputation is closely tied to its ESG performance. Investors, customers, employees, and other stakeholders increasingly scrutinize a company’s ESG practices. Acquirers are aware that a target company’s poor ESG performance can negatively impact their own reputation and relationships with stakeholders, leading to deal cancellations to protect their brand image.

3.    Regulatory Compliance: Many jurisdictions are introducing or enhancing regulations related to ESG reporting and practices. Acquirers may cancel deals if the target company’s ESG practices do not comply with current or upcoming regulations. Non-compliance could result in fines, legal challenges, or disruptions to business operations.

4.    Financial Impact: ESG issues can have financial implications. For example, environmental liabilities or poor labor practices can lead to unexpected costs, impairments, or loss of business opportunities. Acquirers might cancel deals if they identify ESG-related risks that could adversely affect the target company’s financial performance.

5.    Long-Term Value: ESG factors can impact a company’s long-term sustainability and value-creation potential. Acquirers are increasingly recognizing that a company with strong ESG practices is more likely to thrive in the evolving business landscape. Canceling deals based on ESG due diligence failures demonstrates a commitment to long-term value preservation and growth.

6.    Integration Challenges: ESG-related issues can be complex to address during post-merger integration. Acquirers might cancel deals if they anticipate significant challenges in integrating the target company’s ESG practices into their own operations or if they believe that the ESG-related gaps are too substantial to bridge effectively.

7.    Investor and Market Expectations: Institutional investors are increasingly factoring ESG considerations into their investment decisions. Acquirers might cancel deals to align with investor preferences and market trends. Demonstrating a commitment to ESG considerations can enhance a company’s access to capital and investor support. 

8.    Materiality and Transparency: ESG due diligence helps identify which ESG issues are material to the target company’s business. If significant ESG issues are discovered that were not disclosed during negotiations, acquirers might view this as a breach of transparency and cancel the deal due to a breakdown of trust.

Overall, M&A deals based on ESG due diligence failures reflect a broader shift in business practices towards more sustainable and responsible approaches, driven by factors such as risk management, regulatory compliance, stakeholder expectations, and long-term value creation.

Business continuity and operational resiliency companies like ReadyGlobal provide structured approaches to identifying and managing risks, ensuring operational continuity, and aligning business practices with ESG principles before due diligence even begin. Companies that integrate ESG compliance into their continuity planning significantly increase greater M&A success.