Turning Green into Gold: The Role of Sustainability in Successful Exit Strategies
By Bettina Denis
Environmental, Social, and Governance considerations are becoming increasingly important to exit strategies as potential acquirers and public markets recognize the value sustainability creates for a company.
Having strong sustainable practices can be the difference between attracting premium valuations and favorable exits – or facing devaluation, increased scrutiny, and even deal cancellations.
The growing emphasis on sustainability is particularly evident in Europe, where regulatory frameworks like the Sustainable Finance Disclosure Regulation (SFDR) classify funds based on their ESG integration. Even in regions like the U.S., where sustainability is more controversial, there is a rise in companies voluntarily reporting their sustainable practices.
While there has been some criticism that ESG factors are too subjective, this should be viewed in the broader context of valuation. In today's market, 48% of the world's stock market value is derived from intangible assets, according to a study by Brand Finance. The intangible category includes items such as brand reputation, team dynamics, and customer relationships.
Sustainability also falls into that intangible category for a couple of reasons. First, it can influence those other intangible assets, such as the ability to hire and retain employees or persuade customers that the company has embraced sustainability. Second, it can be a strong indicator of long-term resilience because investors will understand that the company is prepared for changing scenarios such as new regulations and environmental impact on the company.
While companies want to know how much sustainable behavior can add to their valuation, it’s more useful to approach this from the opposite direction: What is the risk of not adopting sustainable practices?
Classic metrics like Discounted Cash Flow feel reassuring because they use a formula that generates a data point. But all such forward-looking measurements include assumptions: the company will deliver on its business plan, hire a great team, avoid governance issues, and not be derailed by new regulations.
The risk of such events has become so high that there is now an entire class of funds (such as Muddy Waters, Gotham City Research...) that search public filings for sustainability weaknesses and then bet a company’s valuation will drop. These short sellers publish the research so the broader markets see these issues and drive the stock down.
So, sustainability is no longer a peripheral consideration, but a core aspect of a company's valuation. Let’s look at some of the key elements of the ESG playbook for exits.
Getting started
Companies should follow several best practices:
1. Understand Buyer Needs: Tailoring the Sustainability strategy to align with the expectations of potential buyers or investors is crucial. Understanding what buyers value most in terms of Sustainability can significantly enhance the attractiveness of a company. Companies should expect that they will be asked many questions on sustainabilty when they want to do a financing round or exit on the listed market.
This is being driven, in part, by regulations in Europe that ask all funds – listed and private – to classify themselves in terms of how they consider Sustainability in their process. More than half of the assets under management in Europe now include ESG as part of their investment thesis.
A recent report by PwC found that 57% of PE firms include ESG as part of due diligence, and 53% said it could be a deal breaker.
It’s not just about regulations. In the U.S., for example, companies are not obligated to disclose ESG matters in their pre-IPO filings, but the number that mentions their sustainable practices continues to increase (by 20%).
2. Conduct Peer Benchmarking and Gap Analysis: This involves assessing where the company stands in relation to its peers regarding ESG performance. Identifying gaps allows the company to improve in areas that matter most to potential buyers.
When it comes to exits, a company can’t afford to lag behind its competitors. You are all part of the same value chain and clients will want to have the best players as a supplier. As regulations force them to evaluate their entire supply chain, a company can’t afford to be seen as a potential problem.
3. Do Not Overlook Climate Risks and Social Shifts: Climate risks and shifts in consumer and employee expectations around sustainability are critical factors that can impact business operations and valuations. Companies must proactively address these risks to avoid future challenges.
For instance, if the planet’s temperature increases by 4%, your insurance costs will increase by 15%. So all operation costs will also be impacted by the climate risks. As for social shifts, 57% of adults between 18 and 30 years old say they would quit their jobs if environmental concerns were not correctly addressed.
4. Develop a Robust Sustainability Strategy: Sustainability strategy should be integrated into the core business strategy rather than treated as an isolated initiative. This ensures that ESG efforts are aligned with the company’s long-term goals.
5. Engage the Entire Organization: In the same way that Sustainability should not be a standalone initiative, Sustainability strategy is not just the responsibility of a dedicated team. It requires the involvement of the entire organization. Everyone should be aware of and contribute to the company's ESG goals, from board members to front-line employees.
Like all projects, you need a leader and a Sustainability team because it takes a lot of energy to make sure that everyone is constantly aware of the initiatives and tracking progress. Share the goals with everyone in the company and talk about the goals at the board level. This creates commitment and shows leadership on the topic. Your best ambassadors are your employees.
There’s nothing worse than putting so much energy into drafting a diversity charter and then the charter ends up on a shelf because no one's aware of the fact that this work was done.
6. Stay Informed About Regulatory Requirements: With over 3,100 climate laws and policies worldwide, staying current on regulatory changes is essential. Compliance not only avoids legal pitfalls but also enhances the company’s appeal to buyers who prioritize regulatory adherence.
Europe has taken the lead in ESG regulation, but the movement is a global one. For instance, California has climate regulations that will impact large companies that want to operate there.
Failure to understand regulations can be costly. In some regions, companies that exceed emissions limits must buy carbon offset credits, money that would be better spent reducing the carbon footprint.
7. Maintain Transparent Communication and Reporting: Transparency in ESG reporting builds trust with stakeholders and potential buyers. Regular, honest communication about ESG efforts and challenges demonstrates the company’s commitment to sustainability.
Don’t pretend. Say what you do. Do what you say. Be transparent and say that you're doing your best to implement it. Failing to deliver can severely damage a company’s credibility.
Source: https://www.resolver.com/blog/esg-washing-dos-and-donts-grc/
8. Showcase ESG Innovations: Highlighting unique ESG initiatives can create a competitive edge. Buyers are increasingly looking for companies that not only comply with ESG standards but also lead the way in innovation. If you have an offering that differentiates the company from competitors, communicate it because it can give you an edge when it comes to investors.
Sustainability and valuation
Companies developing their exit strategies need to move past viewing ESG as a compliance requirement or a burden: sustainability is not a trend. It's here to stay. It’s about risk management and creating value by improving the business.
Realizing that potential requires collaboration across the organization around ESG goals and a clear understanding of how these efforts contribute to the company's overall success.
Companies that successfully integrate Sustainability into their exit strategies can achieve higher valuations, smoother transitions, and sustained success post-exit.
A strong sustainability program becomes a powerful asset, making the company more attractive to buyers and increasing the chances of a successful exit. As the business landscape continues to evolve, companies that prioritize Sustainability in their exit strategies will be best positioned to turn green into gold.