Environmental, social and governance (ESG) is slowly transitioning from a risk factor in merger and acquisition (M&A) transactions to a potentially favorable term. This transition has sparked a rise in “green premiums” in M&A transactions, where sustainable companies almost always demand a price premium.
This article will explore how sustainability is changing the valuation process and, more importantly, how companies can leverage this trend to their advantage. If you’re looking for specific advice related to an upcoming deal, it’s best to speak directly with a team of experienced M&A advisors.
The Rising Role of ESG & Sustainability
Companies and investors have historically viewed ESG as a potential risk factor when pursuing an M&A deal. If a potential target company didn’t abide by industry regulations or guidelines, then it could potentially be subject to fines or lawsuits that could hinder future growth. However, many companies are starting to change this stance on the issue, and now view ESG as a potential opportunity.
There are a number of reasons why ESG factors are being viewed more favorably:
- Potential Revenue Increases: While regulations still pose a risk, the ability to overcome these barriers could also provide access to new markets, increased customer engagement, or pricing power.
- Recurring Cost Savings: While implementing sustainability practices is often done out of regulatory necessity, it could also lead to improved operational efficiency that helps cut costs
- Improved Cost of Capital: Increased operational scrutiny in order to achieve compliance could also optimize capital expenditures or help companies gain access to alternative funding sources that are available to sustainable companies.
- Strength of Management Teams: Strong ESG performance is typically a reflection of the company’s leadership team. If a company excels at ESG, there’s a strong chance that it outperforms in other areas and will continue to do so.
Companies that actively prioritize ESG and sustainability factors now find themselves commanding a pricing premium in M&A deals, known as a green premium.
What is a Green Premium?
A green premium refers to an increased valuation that companies with strong ESG practices can command in an M&A transaction. The premium is a result of increased market demand for companies that own green assets, technologies, or operational knowledge.
Almost all green deals demand a premium of some sort in today’s market, with green premiums reaching as high as 20% to 30% in some industries, according to the Institute for Mergers, Acquisitions, and Alliances. So does this mean that acquiring companies should always accept a 20% to 30% premium when targeting a sustainable company? Not quite.
One study by the University of Pennsylvania discovered a benchmark:
“For every 10% increase in emphasis on material ESG concerns, a company’s value increases by 1.4%, while a similar increase in attention on non-material ESG matters leads to a 3% decline in value.”
That said, there are plenty of other factors for acquiring companies to consider. For example, will the target company enhance the acquiring company’s own ESG goals? If so, will that lead to increased revenue? What about access to new markets by overcoming regulatory barriers? Increased customer engagement? All of these questions (and more) must be quantified and factored into the deal.
AI-powered valuation tools can help create a starting point for valuation. But with so many factors involved, it’s recommended to work with a team of M&A professionals who can help ensure that all ESG deal terms are accurately valued.
ESG in Action: Holcim’s Green Acquisition Strategy
When approached correctly, prioritizing ESG in an M&A deal can also be a major growth driver. Holcim’s green acquisition strategy during the 2020s is a clear example of this.
Holcim, now a leading sustainable construction company, made several strategic acquisitions to enhance its sustainability practices, while also increasing revenue.
Most notably, Holcim acquired Malarkey Roofing Products in 2021, a company that specializes in residential roofing with an emphasis on sustainability. During the announcement, Holcim described Malarkey as “A highly regarded brand with leadership in innovation and sustainability in Holcim’s biggest market.” In 2022, Holcim also acquired PBR, another “Highly regarded brand with advanced sustainable and renovation solutions.”
These acquisitions helped boost Holcim’s sales growth from 8% in 2020 to 19% in 2022, according to BCG. At the same time, Holcim was also able to reduce its CO2 emissions per net sales ratio from 5.1 to 3.7, significantly outpacing industry peers.
Should ESG Be a Top Factor in Your Next Deal?
ESG factors are no longer about simply staying compliant and avoiding penalties. In today’s M&A market, companies are actively associating strong ESG performance with growth potential and opportunity, resulting in “green premiums” for sustainable companies.
The emergence of the green premium reflects a growing investor appetite for businesses that align with long-term environmental and social trends. As case studies like Holcim demonstrate, embedding sustainability into your acquisition strategy can accelerate growth, strengthen market position, and unlock meaningful shareholder value.
However, similar to the role of culture in M&A success, quantifying ESG value and integrating it into the due diligence process is a difficult task that requires a clear understanding of how ESG factors align with your broader strategic objectives. Whether you’re on the buy or sell side of a deal, navigating these evolving standards is key to deal success.
Are you planning to factor ESG into your next M&A deal? Contact the Acquinox Advisors team today to help you evaluate ESG risk and upside, structure smart deals, and unlock long-term value.
