- Richard Massony, Associate , Hunton Andrews Kurth LLP
- Andrew Sherman, Partner, Seyfarth Shaw LLP
- Bella Zaslavsky, Partner, K&L Gates LLP
- Introduction to ESG Issues and Trends
- ESG & Fiduciary Duties
- ESG Opportunities in Transaction Financing
- ESG Due Diligence and Risk Mitigation
- Negotiating ESG-Related Deal Terms
- Post-Closing Considerations
John Jenkins, Senior Editor, DealLawyers.com: Hi, this is John Jenkins, Senior Editor of DealLawyers.com. I’d like to welcome you to today’s program, ESG Considerations in M&A.We have a terrific panel to discuss these issues today. I’d like to introduce Richard Massony, Associate at Hunton Andrews; Andrew Sherman, Partner at Seyfarth Shaw; and Bella Zaslavsky, Partner at K&L Gates. Andrew will get us started with an introduction to ESG issues and trends.
Andrew Sherman, Partner, Seyfarth Shaw LLP: Thank you, John. It’s great to be with all of you. We assume that if you’ve tuned into this webinar, you are a deal lawyer. You’re probably wondering what you need to know about ESG and how this panel can get you conversant with these issues, so that you can talk affectively to clients and know how it’s going to impact not only transactions today, but transactions of the future. We are going to divide this up into six different sections, with each of us leading two of them and commenting on each other’s sections as we go. The first one is an introduction to ESG, and then we’ll get to the other topics.
First, let’s define the concept. It’s not really fair to assume that if you’re listening to today’s webinar that you know exactly what this acronym stands for or why it’s important. Even the acronym itself can be a little deceptive because in some ways, ESG means a lot more than the three letters: Environmental, Social and Governance. It has five general categories. Environmental may be pretty straightforward to all of you, as it includes a wide variety of things: carbon footprint, carbon emissions, water, waste management, raw material sourcing, global warming and biodiversity land contamination. It’s everything you think your environmental partners down the hall worry about and that you turn over to them when you do environmental representations and warranties.
However, not in the title but implied by the word “social” are workplace, community and marketplace issues. These are much deeper than just the “S” in social. They include all kinds of issues around supply chain, diversity and inclusion, the ability to embrace gender equity and equity payment issues — all kinds of issues that, frankly, you’d have to be pretty well asleep at the switch to not be watching.
You may remember the acronym CSR, Corporate Social Responsibility. CSR was the acronym from 10 or 15 years ago that implied a company needed to be a good corporate citizen and function in a way that respected the ecosystem, or multiple ecosystems, in which it operates.
Lastly, the part in the acronym that you’re most familiar with: governance. Most of you — if you’re listening to DealLawyers.com — know what good governance is. But good governance has taken on its own new set of components around not only good governance, but responsible governance. The importance of informed decision-making and the evolution of the business judgment rule, diversity and inclusion comes up again under the “G” of governance, at both the board and leadership level.
Something I could literally talk about for hours — but I won’t, or my co-panelists will be irritated with me — is the business roundtable pronunciation from a year or so ago around stakeholders versus stockholders. We’ll be touching on this throughout the program, but that was a pretty major pronouncement by 250 of the most prominent companies in the world, and it was around the time that ESG started creeping into the nomenclature of the capital markets on Wall Street.
There has been pressure — not just created by the reality of COVID-19 and its impact on our work lives, social lives, retirement, and perspectives on life — but it’s also forced this larger issue of realizing that a corporation’s role is broader than just returning a profit and enterprise value increase through its shareholders. For about 100 years, that’s how it was defined and boards were guided by that metric in their decision-making.
However, now we’re seeing companies going from progressive to mainstream. When I was a young lawyer, companies like Ben & Jerry’s or The Body Shop would get recognized for their ethical treatment of animal testing and diversity in their supply chain. But now, as recently as yesterday, Exxon Mobil’s CEO went on CNBC and talked about the company’s commitment to ESG standards and ESG strategies. Other Fortune 100 leaders, such as Nike and Home Depot, have recently made pretty strong ESG pronouncements, private equity funds, venture funds, ETFs and mutual funds, all talking about the importance of ESG.
As John hinted at the beginning, ESG is now at a minimum accretive — possible neutral, but absolutely not dilutive to enterprise value. So, it’s very important to keep your head in the business news. Whatever your favorite channels or newspapers or sources may be, keep an eye on how ESG issues are evolving. Not just in general terms and in the capital markets, but also in the context of transactions, which is the focus of today’s program.
A big part of this is connecting the dots. Looking at things like what’s going on with the Robinhood investors and the Reddit Army, and all the GameStop news. Pressure to democratize the capital markets is very much a part of this. It’s the voice that’s been enabled by Web 3.0, social media and digital strategies. Its boards are now having to pay attention to these voices more carefully. Consumer action is more important than ever and companies are beginning to embrace the influence of the United Nations 17 Sustainable Development Goals at a rapid shift. We are clearly living in an era of transparency, activism and empowerment. I don’t think it’s a fad. If you’re thinking, “ESG sounds like a fad that will be gone next year, replaced by something else,” that’s not going to happen.
A recent study by PricewaterhouseCoopers said that 88% of institutional and individual investors believe that companies that prioritize ESG initiatives represent better opportunities for long-term returns than companies that do not. Eighty-eight percent is a big number. I believe that this notion of doing well by doing good is very much here to stay. I have a little bit more on the intro before we get to our second topic around fiduciary duties, but let me pause there and ask Richard or Bella to weigh in. What other trends have you seen that make ESG or should make ESG at the top priority list of every deal lawyer and corporate lawyer?
Richard Massony, Associate, Hunton Andrews Kurth LLP: I just wanted to pipe in on the point you were making about this not being a fad or trend, but something that’s going to be here to stay. That’s absolutely true. I started following these issues a couple years ago, and it’s only grown from there. The number of clients reaching out and asking for thoughts on ESG matters and how they might make acquisitions either solely or principally for ESG purposes has grown substantially. There was a private equity client we worked with when we were putting together a diligence list, and diligence is one of the topics I’m going to talk about later. They had prepared an in-house diligence request list solely focused on ESG issues that was over 10 pages long.
These are things that are important to note because investors and stakeholders are really focusing on them. There’s a lot of noise out there. It is a sexy buzzword, but I don’t think it’s something that’s just going to go away in a few years.
Sherman: I couldn’t agree more. Some of you who are listening in might be shocked that there would be a ten-page checklist or augmentation of the diligence list just on ESG issues. I know the three of us are not shocked. If you’re out of the loop on these things, we hope to give you as much information today as possible, but it is time to pay attention to it. Bella, any quick thoughts? I’ve got a few things to add before we get to the next segment.
Bella Zaslavsky, Partner, K&L Gates LLP: I wanted to add that when we discuss ESG and M&A, the focus often is on the target company and its ESG framework and strategy. Recently, we’ve also been seeing that targets also care about their acquirer’s ESG perspectives and the things that they’re doing. We’re working on an auction process and one of the matters being addressed by potential acquirers in their draft is their focus on ESG, which is something I had never seen before, but I think it’s going to start appearing more and more. It’s not just how much you’re willing to pay, but also, what is your culture, perspective and strategy?
Sherman: 100%. I agree with Bella very strongly. I do think that what’s going to happen as soon as your client either very actively or semi-actively embraces ESG principles. To Bella’s point, none of those clients are going to want to dilute, injure or harm their ESG principles and ESG public persona by doing an acquisition of a company that doesn’t embrace ESG principles.
If you’re on the buy-side, you’re going to have to get with the program. If you’re on the sell-side, you need to get your client focused on its ESG warts, if you will, or non-ESG compliance, because that could be a real turn off to an ESG-conscious buyer and it could be a diminution in the enterprise evaluation of the seller. No matter what side of the transaction you’re on — and Bella’s going to talk a little bit about the financing sources and their demands — they’re all going to make this a priority, even if you’re just representing the private equity or the deal financing money.
The last thing I’ll say by way of introduction is that it’s important that none of you think that ESG is some soft, squishy topic. There is a major effort underway to create indices, metrics and key variables. I mentioned the United Nation’s 17 Sustainable Development Goals. I would urge all of you to take a look at that and make sure you’re familiar with them. There are other ESG metrics and reporting being developed. We all know that phrase, “We manage what we measure.” The expectations, transparency and accountability are most definitely here to stay. It’s not just some CEO of the company doing a ribbon cutting at the local community center with the giant, oversized check for $25,000. It’s much deeper and more sophisticated than that.
Sherman: Let me turn to our second topic before turning it over Bella, who is going to address transaction financing. The second topic is a little more nuanced and it’s still very early, probably in the first or second inning. That is, what do your clients, and you as advisors to your clients, need to know about ESG and fiduciary duties? We all know the board’s and the C-Suite’s obligations and duties to its shareholders. We know that the business roundtable recently opened up that definition to include stakeholders’ and company’s ecosystems, but what kinds of fiduciary duty risks are there if your client has their head in the sand and is hoping that ESG will just go away? Or ignoring it or not embracing it?
The first issue is a reality check from a fiduciary duty perspective. We’re at the point where boards and the C-Suite need to genuinely commit to ESG, CSR, social justice principles and good corporate citizenship. A, because the law either requires it directly or indirectly. B, because of market and consumer factors. And C, as John hinted at the outset, because it will, in fact, drive enterprise value. If those three things are true, you are putting the company and your breach of fiduciary duty in peril if you’re not embracing those things.
Second, to hold ESG accountable in terms of evaluation of investments, transactions and projects — that’s the introduction to today’s focus. It’s not just M&A — it’s strategic investment, corporate venturing and budget allocation. I think any company that would one day be put under an ESG microscope or an ESG audit is going to have to be held accountable to show that they allocated shareholder resources accordingly.
Lastly, there’s a piece that is going to develop around metrics and accountability, where if their board or leadership of the company is not taking ESG seriously and fails to meet those metrics, they could be held accountable. So, with that, I would invite Richard or Bella to weigh in further on the fiduciary duty issue. Or if you think I’ve nailed it, since it’s still early stage, we’ll move to the third segment of the program that Bella will be leading.
Zaslavsky: You nailed it. As Andrew mentioned, we’re going to talk about ESG with respect to M&A and transaction financing. ESG issues are impacting both the availability of acquisition financing necessary to complete transactions, as well as post-closing financing for ongoing business needs. Particularly over the last few years, there has been an increased focus on ESG matters in M&A. The various sources of traditional funds, lenders, private equity firms and venture capital investors have been paying more attention to sustainability. We’ve seen asset managers and institutional investors — notably BlackRock, State Street, and Vanguard — putting out statements to their portfolio companies that ESG issues are going to be a focus in making investment decisions.
As Andrew noted at the top of the program, we’ve seen private equity firms and venture firms increasing their focus on ESG matters. The current pressure to include an ESG framework is coming both internally from their LTs and members, as well as their own sources of capital with their lenders thinking about their own ESG strategy. There’s an increased awareness that firms and funds that do focus on sustainability are a better credit risk.
Those firms will likely have better access to capital if their portfolios are diversified and focus on long-term sustained growth. This increases opportunities for companies that have a green or sustainable objective and practices. What does that mean, exactly? Well, there’s no simple answer to that question. I’ll have Richard or Andrew weigh in on that in a second. Right now, although ESG financing is becoming increasingly popular, substantive market norms have not yet evolved with respect to documentation practices, metrics and things like that.
Many companies do provide ESG disclosure that is often focused on existing sets of standards, such as the SASB, PCFD and GRI, but please don’t quiz me on exactly what those all stand for. However, the practices aren’t universal, and there isn’t really a convergent way of reporting standards and disclosure. If buyers are seeking financing and have a lender that has adopted a specific set of standards, they should consider factoring that into their own diligence request to address compliance with those standards, and the target’s compliance with those standards. Andrew and Rich, do you have anything else?
Sherman: You’re right. Those standards are not in place, and there is an optics and branding issue. I love the point you made about beginning to perceive these companies as a better credit risk and corporate citizen. That’s an important observation. However, I would warn our audience that just because these standards don’t exist yet doesn’t mean they’re not coming. You’ll hear Richard, Bella and me talk about us being in the first or second inning of this. Some would say we’re still in the warm-up swings, but it’s coming. We’re all sure of it.
Massony: That’s absolutely right. Bella, you mentioned that BlackRock’s CEO, Larry Fink, put out a letter to CEOs and laid out BlackRock’s thinking on ESG matters. I would recommend it to everyone who’s on the call, just to see how they’re thinking about these issues and how they’re pushing these standards.
Sherman: Yes, he just reiterated and doubled down on that messaging in his 2021 letter. Other big private equity funds are following his lead. It’s another great resource for our listeners to read after this session, if you want to learn more about why the three of us feel so passionately about this.
Zaslavsky: That’s where we are with respect to financing. I absolutely agree about reading Larry Fink’s letter. It’s a good read in addition to being informative. Now, I’ll kick it over to Rich, who’s going to talk about ESG due diligence and risk mitigation.
Massony: I’ve got two topics here, back to back. The first one is due diligence and risk mitigation in ESG, and then negotiating the definitive agreements and taking into account how ESG issues might come up there. These are two practical areas that will be helpful to a M&A lawyer, with advice you can use to demonstrate to your clients that you’re aware of ESG issues and considering them thoughtfully.
Let’s start with the first one, due diligence. How does ESG due diligence differ from run-of-the-mill regular, legal due diligence? I like to think of it as not being a new category. Indeed, all of the categories of ESG due diligence are already covered in standard due diligence. There are environmental and labor issues, employment matters. But I think of it more as a broadening of the scope of legal due diligence across a number of areas.
Whereas general due diligence might focus on areas of acute legal risk—for example, is the target breaking the law? Is it in breach of its contracts? Will closing the transaction cause the target to break any laws or breach any of its contracts?—ESG due diligence might look beyond the purely legal risk and ask questions like: What is the potential for reputational harm to a company if they consummate a transaction? How might the target’s operations or policies be misaligned with the desires of the acquirer’s stakeholders? And what are the target’s values and culture? And how do they mesh with the acquirer?
You have probably come across a lot of these issues in standard due diligence, and you may have even mentioned them to clients. But, as Bella pointed out, there is growing force—and capital—behind these ESG considerations that makes them more salient. The focus is really heightened. For instance, in the past, you may have come across in your due diligence about employees and employment matters of a target that there are a lot of complaints from workers about working conditions and inflexibility about working from home, which may not have raised acute legal concerns. But now, in the age of COVID-19, that could be a major problem. You might have raised an eyebrow in the past if you saw that a target has been unable to retain or promote women in the workforce or in executive management. Again, maybe that previously did not pose an acute legal risk, but now it might be worth taking a closer look to see if there’s an issue with sexual harassment or misconduct in the workplace.
Those are some of the areas where ESG due diligence is a broadening of the scope of traditional due diligence.
Sherman: Richard, you’re making some fantastic points. I want to make sure our listeners are not confusing traditional due HR compliance with labor and employment compliance. And, of course, deal lawyers for 50 years have brought in our labor employment experts to make sure that EEOC and all kinds of check-the-box policies are met.
What Richard is talking about is much deeper than that. It goes to values, culture, fairness, empathy, integrity, employee engagement and workplace giving. Just don’t be surprised if you’re on the sell-side and you get a whole augmented list of due diligence questions around these things and you’re thinking that this goes way deeper than the traditional labor and employment compliance diligence list. This is now trying to get into the heart and soul of the company. Don’t push back — to Bella’s point, if you push back, the third-party financing source that’s doing that acquisition may not support the acquisition or might trigger a covenant violation. This is serious stuff.
Massony: I absolutely agree. A lot of this part of the presentation is about due diligence. I’m thinking about it from the buyer’s perspective, but it is smart to also consider it from the seller’s perspective of being the recipient of a ten-page ESG due diligence request list, so you can explain to clients where this is coming from. There may be some clients who think of that as an abstract concern and wonder why they have to respond to these things. Then you can explain to them that this is important to the people who are financing transactions.
Sherman: I’ll give you one quick example: the Amazon ad that ran during the Super Bowl is the most expensive type of advertising. If you’re Amazon and you’re spending tens of millions of dollars on advertising about getting to a zero-carbon footprint by 2040, the last thing you want to do is acquire a bunch of companies that are polluting everywhere.
Massony: That’s exactly right. So, the first thing in terms of doing ESG due diligence is to ask some preliminary questions about your client. As I said before, my presentation is from the point of view of an acquirer. You need to think about the acquirer’s needs and to take Andy’s Amazon example — what are they going to be looking for in terms of ESG? If you’re representing a large, sophisticated company like Amazon, look at their website. They’re not going to be shy about these policies. They’re probably going to have very fancy, splashy ESG pages with PDFs with pictures of smiling workers and windmills. So, you can get a sense of their policies just by looking at these documents — what is the acquirer trying to communicate to its investors, customers and employees about its values? Getting a sense of that will help you figure out what you need to look at in terms of the target.
You also need to think about the acquirer’s ESG implementation and how they will be looking at ESG. Do they have a team or person who is directly responsible for ESG? Is there a point person on the deal team? This is obviously in the context of legal diligence, but a lot of times, ESG is just as much of a business consideration. You don’t want to get too far down the road of doing ESG diligence and realize your client has someone handling it on the business side.
Next, you need to ask some preliminary questions about the target. Those will be framed around the buyer’s needs. How sophisticated is the target? Is it a big, public company that has a history of catering to shareholders? Or is it a small, family company that hasn’t had to report?
Where does it operate? If it’s in the EU and it’s a public company, it may already be used to complying with certain ESG regulations. But if it’s in an emerging market, it may have never seriously engaged on ESG matters at all.
Who are the target’s customers? Are they consumers? Are they commercial customers? Are they government customers? These are important questions to understand what to expect from the target.
One helpful tool for understanding an appropriate scope of ESG due diligence is the materiality map on SASB’s website. It includes a listing of material concerns on an industry by industry basis. You can click on an industry, and it will tell you which ESG issues are material to that industry. It can help guide your focus on ESG diligence. If you click on healthcare, for example, you’ll see that the SASB materiality map shows certain ESG categories that are particularly important, such as data security, product quality and safety, customer welfare, product labeling and business ethics. The SASB materiality map may also reflect that in the healthcare industry; there’s not so much focus on carbon emissions or vice versa. It could be a helpful way to frame your diligence.
Then, there is the question of: what are the additional ESG-related diligence requests? I will spare you a reading of a 10-page ESG diligence request list, and I’ll just go through some of the broad categories.
In terms of social requests, it’s important to identify the areas that are most important to the buyer and the industry. Supply chain transparency may not be that important to a manufacturer of industrial equipment, but it may be crucial for a manufacturer of consumer electronics, whose consumers are going to care about where their products came from.
In terms of workplace diversity, you may ask if there is a policy or strategy, and whether it sets concrete goals. Can you look at those goals and compare them to their track record? In terms of workplace diversity, one of the things you can request is an EEO-1 report developed by the EEOC, which gives race and gender data for employees. There’s a whole other host of issues — you could add health and safety, COVID-19-specific requests, as well as sexual harassment and misconduct. In the age of Harvey Weinstein and #Metoo, it’s important to tailor a diligence request list to reflect that there may be something that’s been systematically hidden. Consider asking for a longer lookback on litigation, asking for the number of employee complaints and for anonymized descriptions of any complaints of a sexual nature.
Specifically for corporate governance issues, you need to ask about the board of directors and management. Ask about the corporate governance structure and their policies and how they match what the company’s representing about ESG on their website. Trying to get at points to determine whether there’s actual substance behind all of the splashy PDFs and promises about ESG that the company’s making publicly.
That’s the end of the due diligence section. Andy or Bella, do you have anything to add before I move on to definitive agreements?
Sherman: Just a couple quick thoughts. We’ve definitely seen much deeper dives into the board. Not just in terms of diversity on the board, but board composition overall, board recruitment policies, the nomination committee, board compensation policies, onboarding and training best practices. There’s a lot going on with the board side.
One issue that we didn’t touch on is intellectual property ownership, lack of infringement or misappropriation. Is the company inclusionary with its employees when inventions and developments are made? It’s an ESG spin to what was already an increasing amount of IP and digital asset due diligence that has been growing for the last five years — including data security, privacy, all that stuff.
Zaslavsky: I wanted to jump in and mention one small thing. If your client, the buyer, is a public company, you’ll want to consider also including in your diligence factors that would potentially impact disclosure going forward for the combined companies based on the quickly evolving SEC initiatives around these areas.
Sherman: One last thing, Richard. When we’re talking about diversity, it’s not just workplace diversity. Please keep in mind that this now includes supply chain diversity. We had an issue come up the other day for a franchise company that was being acquired by private equity and the private equity, to Bella’s point, asked a bunch of questions about why all their franchisees were older, white men and not enough women or minorities. So, the DNI issue is much broader than just workplace.
Massony: All right. Moving on to the next topic: definitive agreements. Now we’re talking about the protections you will build into your purchase agreement. As I noted in my discussion of diligence, a lot of these ESG issues are not entirely new. They’re getting increased focus, or the lens is pulling back a little bit further on what’s of interest to buyers and to their stakeholders. Where purchase agreements previously included socially salient issues—like conflict minerals, for example—we are starting to see some other ESG categories be addressed in purchase agreements.
The first category I’ll talk about is in the reps. Where are ESG issues showing up in reps? The first question is if the target has made ESG disclosures on their website or otherwise. Are they accurate? If so, is your client basing its acquisition decision at least in part on some of these ESG matters being true?
One example I like to give as a thought exercise is to think about Patagonia, the clothing retailer — they make a big deal out of their products being fair trade certified. They’ve partnered with a third party, Fair Trade USA, to certify their products as being fair trade. They have fair trade worker committees, promote worker health and safety, and encourage dialogue between workers and management. Imagine a scenario where you’re representing Patagonia and they’re looking to acquire a manufacturer and the target holds out that they comply with these fair trade standards. That may be an area where you want a very specific rep about their compliance with fair trade and specific things that they are doing to remain in compliance.
Another example of an ESG rep are so-called Weinstein reps. These say that for a certain time period, there have been no sexual harassment or assault allegations made against the company’s senior employees or officers, and that they haven’t entered in any settlement agreements with respect to such behavior. There may be these lingering issues that would have not surfaced otherwise.
The interesting thing is that we have started to see these Weinstein reps expanded beyond just sexual harassment and assault. We have seen these reps used with respect to racial or gender discrimination, for example.
Sherman: In a consumer products deal, we recently saw a rep and warranty around responsible packaging and recyclable packaging, and I was like, “Go ESG. Here it comes.” There are so many cool examples of what’s popping up.
Massony: Absolutely. In addition to reps, you also have forward-looking covenants on ESG matters. There are a lot of deals where this won’t be applicable, where the buyer and seller are parting ways. However, there are a lot of situations in M&A where it may be applicable, like in a rollover transaction where a seller is maintaining an interest in the target company, or in the context of a joint venture. You may want some forward-looking covenant about certain activities that won’t run afoul of ESG principles. You can do this with very general language, which we have done in some of the transactions I’ve worked on. We’ve been able to get agreement on not doing anything that would cause either party reputational harm. However, that might not be specific enough.
One thing you may consider is trying to tie these covenants to third-party standards. There may be specific ESG standards that exist today or are being developed that you could require the company comply with going forward. Recently, I dealt with a joint venture between a large institutional client and a closely held family company. They were restructuring the joint venture where the family company was giving up some control. However, they were concerned about the joint venture being involved in activities that they weren’t comfortable with. The family company’s attorney proposed a covenant that the joint venture entity would not engage in any activity that was listed on the IFC Exclusion List, which is a list created by the World Bank. It includes prohibitions against things like the industry or trade in weapons, ammunitions, production of radioactive materials, production of asbestos, gambling, alcohol, tobacco, and then some oddball things like drift net fishing and rain forest deforestation.
Using some of these third-party lists may be helpful and good shorthand, but it’s important to be careful about what is actually in these lists. Do they really make sense? And thinking down the line, are they potentially too restrictive? Will they change over time? Andy, are you coming across any covenants in the ESG contexts in any of your transactions?
Sherman: No, I think you nailed it. We could almost do a separate program on the cross-border stuff you mentioned earlier. What do you do in an ESG situation where you’re crafting a covenant that’s a little “U.S. centric” and you’re in a developing nation that may look at that rep and warranty and say the cultural norms are not the same? There are countries all over the world that don’t treat people with the same commitment that we do, or where gender equity pay issues are still decades behind. I’ve run into some cross-border problems when I try to insert reps, warranties and covenants that are ESG oriented and clash with the cultural norms of the target country.
Bella, why don’t you take over post-closing and leave us each a minute or two to get some wrap-up comments?
Zaslavsky: Post-closing, one of the most essential items will be integration. This is where some of the diligence we’ll have done will come into play. The buyer will have wanted to develop a plan to address any material ESG risks that were identified, and also monitor any kind of remedial efforts and compliance. Aside from that, there should also be an action plan for aligning the target’s ESG policies with those of the buyers. This involves either creating new policies or making sure that there is an effective communication to employees, shareholders and lenders in certain cases. Sometimes, you might find the diligence of the target has some ESG practices that actually are better than the acquirer’s. In this case, the acquirer might consider integrating those, messaging that to their employees and then ensuring those get implemented.
Ideally, an assessment will have been done in advance to determine whether or not the acquirers are compatible on ESG matters. If they’re not, they can still obviously be integrated, but that could cost more, and a buyer might want us to incorporate that additional cost into its purchase price. One method we’ve seen for motivating these integrations would be performance metrics. They could be used to tackle payouts, earnouts, callbacks, or penalties relating to ESG matters and integration, and hitting certain metrics. There could be vesting conditions to equity granted to the targets, such as management from the target that would be responsible for implementing changes.
There are also post-closing disclosure, fair public companies — their target’s practices might now impact disclosure with the parent entity or the combined company. There might also be lenders that need to be kept aware of these obligations. But then, in addition to any kind of required disclosures, there are also voluntary disclosures where you’d want to be aware of the company’s, the acquirer’s, and the target’s website and social media presence. Make sure that their messages are aligned so that they’re not contradicting one another. Rich or Andy, is there anything else that you’ve seen as far as post-closing?
Sherman: I want to reinforce thinking of this as both carrots and sticks. I love that point you made. If you’re trying to make sure that there’s good ESG compliance after the closing period, and that it doesn’t start being dilutive to the acquiring company’s reputation and brand, don’t just think about penalties or holdbacks. Rather, you could use things like an ESG-driven earnout or rewards or additional stock grants on rollover if ESG metrics and objectives are met.
Zaslavsky: Absolutely. That’s all I had for the post-closing. Rich, do you have something else you wanted to add? Otherwise, we can give our one-minute debriefs.
Massony: I don’t have anything specific to add there. Going into debrief mode, I think that it’s helpful for clients to start thinking about these issues and their transactions early. In your standard due diligence request list, it may be a good idea to start including some of these topics and broaching the topic proactively. I think that clients will appreciate it and it will demonstrate some sophistication on your part in understanding the trends in M&A and where this is going. It will also prepare them for addressing those issues down the line.
One thing about ESG that I always struggle with is its enormous scope. It touches a lot of different areas. Because of that, it’s helpful to be able to break it down for clients and introduce them to how it relates to existing considerations in M&A, and where it’s unique and where it’s perhaps a broadening of existing principles. It’s going to be a tremendous driver of value for clients. Not to be too much of a cheerleader for ESG, but I really do think that it’s going to be a big part of the future of M&A, and something that we would all be smart to keep our finger on the pulse of.
Sherman: Bella, do you want to go next for some wrap-up thoughts? And after that, I’ll take us home?
Zaslavsky: I don’t think I could top what Rich said, but I want to re-emphasize what he said. Andrew mentioned a few times that we’re in the early stages and everything is rapidly evolving. For both yourself and your client, make sure that you’re keeping up to date with new guidance industry standards, because it seems like they are continuing to change and evolve almost daily.
Sherman: Let me address three broader points. One, as the old man on the call, I’m going to give some career advice. I’ve been at this for 35 years. I’m pretty sure that Richard and Bella are slightly younger than me. If you, as a transactional lawyer, are looking to differentiate yourself, this is a really cool area. There are not too many areas of the law that you can get your feet deeply into during the first or second inning, and by the time we get to the third or the fourth inning, you can be the resident expert in your firm.
I do think that corporate social responsibility and green consumerism have been around for a while, but ESG is a much more holistic, comprehensive umbrella of areas of expertise that could be a real way for you to differentiate yourself and develop an internal brand. You’re not just another deal lawyer in a hundred-lawyer shop. You’re the go-to ESG transactional lawyer.
Remember, there’s also a big advisory piece to all of this. We’re getting a lot of non-transactional ESG requests right now as a firm. These are from counselling boards and leaders looking at employment, supply chain and distribution policies, and all making sure that they’re ESG compliant. That’s point one.
Point two: we had a change in administration this fall. For those of you who are thinking that ESG principles are voluntary, you better get ready for four to eight years of an administration that possibly views ESG as mandatory and regulatory. We’re only a few months into the Biden Administration, but we’re already seeing a lot of beefed-up environmental regulations and things that are going to be coming out in response to the stripping out of some of those commitments of the previous administration. That’s not to get political; I’m not here to say whether that’s right or wrong. It’s just reality. We have a new administration with a new agenda. The president has spoken many times about carbon footprint and a commitment to environmentalism, and so it’s only natural that you’ll see that trickle into covenants and reps and due diligence and post-closing.
The third thing I’ll say is that even if you ignore career advice what may be happening inside the Beltway and with Congress, what you can’t ignore is market forces. When Exxon Mobil goes on national television and talks about an ESG agenda, it’s only a matter of time before Chevron and its competitors are going to feel the need to do the same thing under market forces and peer pressure. When Nike and Home Depot come out with strong ESG pronouncements, it’s only a matter of time before Under Armour, Adidas, Lowes and Tractor Supply come out with their own pronouncements around ESG. No company can afford to ignore these principles when their largest competitors are making pretty big deals out of ESG.
To both Bella and Richard’s point, no acquirer or source of finance will tolerate you having your head in the ESG sand and not paying attention. They’re not going to dilute their brand and reputation or the investments that they’ve made in convincing the public and convincing themselves that they are not only ESG compliant as more metrics and standards come out, but that their commitment to ESG is not just a check the box or PR stunt. Right now, we’re in this digital era of transparency, and if a company is not authentic and genuine in its commitment, it will be outed by somebody or someone much faster than they would’ve been 20 or 30 years ago.
Jenkins: Terrific. If I were to leave anybody with any thoughts, it would simply be that you can’t view ESG as a feel-good or regulatory issue. If you’re in M&A today, and I think more so in the future, we’re talking about an evaluation issue. There are opportunities if you’re a seller, because buyers are looking to be able to tell a good ESG story — if your ESG house is not in order, it needs some attention. With that, I’m going to thank our panelists for a terrific discussion, and thank you all for joining us. Have a great day.