M&A (and organic alternatives)
SELL-SIDE M&A CONSIDERATIONS
For those corporates looking to divest businesses that detract from their sustainability transition pathway, particularly energy and resources businesses, there are broadly two options: a demerger or other public process like an IPO, where the business itself becomes publicly listed; or an outright sale (often by way of auction) either to a private or listed buyer.
Corporates must remember that the pre-requisites for a successful demerger (or other public process) and a successful sale process can be quite different.
Sell-side M&A considerations - Demerger
Here the newly demerged business is put in the hands of existing shareholders (who may or may not want it) and thrown into the world of the public markets with all of the regulatory obligations, investor (and other stakeholder) expectations and public scrutiny that comes along with public company life.
Shareholders and public markets more generally need to be able to buy into the sustainability strategy of the demerged business for any demerger to launch successfully. As a result, a demerger of one of these kinds of businesses is more likely to be successful where there has been detailed thinking upfront about how to pivot the business strategy towards a more sustainable future (and ideally some kind of operational track record to demonstrate that the chosen strategy is working).
Sell-side M&A considerations – Outright sale
This route is less constrained than a demerger. It offers a way for a seller to make separate private disposals of the various parts of a business where buying demand is sufficient or where the equity story does not stand up well enough to support a demerger or other public process.
Scrutiny from investors and other stakeholders of the identity and sustainability credentials of a chosen buyer for these kinds of businesses has, in our experience to date, been light; but it is increasing. Indeed, we have seen corporates prioritise purchasers in competitive processes who they determine to be safe custodians for assets even if that meant not achieving the highest possible price. We have also seen transactions where the primary or sole goal has been to find a sensible home for an asset or business regardless of the sale price ultimately achieved. In some cases this might mean choosing a more established operator over a niche player.
For example, in its sale to Woodside Energy, an Australian listed business, BHP’s oil and gas business will remain subject to the scrutiny of public markets and institutional shareholders in a company which has a stated transition plan and makes a virtue of its sustainability credentials notwithstanding its status as an oil and gas company.
In the longer term, we expect it’s more likely that sellers will need to do more reverse diligence on their chosen buyers to ensure that they are an appropriate new custodian for all stakeholders affected by the disposal. This will include ensuring that the buyer has a sufficiently strong credit rating to manage the asset properly, an operational track record, good compliance with regulatory considerations, and a sensible social licence to operate. Failure to adequately investigate these points poses a significant reputational risk to the seller.
Although still uncommon, there is also the possibility of insisting that the chosen buyer sign up to sustainability-related undertakings about how they will run the target business or anti-embarrassment clauses to mitigate against ‘bad’ behaviour. Widespread adoption of these provisions is some way off, but if stakeholder expectations of corporates who choose to divest continue to increase, measures of this kind are likely to become part of the sustainability M&A playbook and would be a logical extension of the reverse indemnification provisions sometimes given by a buyer in favour of a seller in respect of assets or businesses with a higher environmental risk profile.
Buy-side M&A considerations
The flip-side of those choosing to dispose of less than sustainable businesses is those corporates looking to make their businesses more sustainable through acquisitions. This encompasses corporates looking to pivot their business to include more sustainable markets to benefit from new exciting growth markets that happen to be green or those corporates who acquire another business or asset which enables them to run their existing operations more effectively.
For those buy-side transactions which are sustainability-driven, due diligence is likely to look a little different to other transactions. There is likely to be a greater focus on commercial due diligence but also on understanding the legal and regulatory framework in which the target business operates. More generally, many buyers in the M&A market now need to consider the non-financial, sustainability-related impacts of the businesses they’re seeking to acquire, just as they need to consider financial and operational qualities.
Although nascent, these considerations are starting to reveal themselves in various practical aspects of a typical M&A process: buyers are increasingly thinking about augmenting their diligence questionnaires with sustainability or ESG-related questions; commissioning sustainability or ESG-specific due diligence reports (often from specialist providers); arranging management or expert sessions with the target business specifically geared towards sustainability; and pushing for warranty and indemnity coverage on sustainability-related matters and more. As climate and ESG-related litigation has increased, we’ve also seen more instances of sellers having to walk buyers through complicated ESG-related litigation.
On the buy side, there is a risk of sustainability-related work on a transaction being distributed throughout widespread diligence workstreams without being properly drawn together and the overall sustainability picture being suitably assessed. Buyers need to remember to pull these strands together, assess sustainability related analysis as a whole and form a holistic view of how the acquisition fits into or affects wider strategy. This will involve asking a range of questions including:
- how well does the acquisition fit into the business’s sustainability trajectory;
- will it be possible to make the necessary operational changes to improve the sustainability of the acquired asset or businesses;
- does the target business have a carbon transition plan;
- what are its stakeholder relationships like;
- what is happening in its supply chain; and
- what legacy and reputational issues does it bring?
Without asking these kinds of questions, there is a risk that acquisitions do not in fact yield the sustainable outcomes that the acquirer hopes for. The temptation for buyers is often to skimp on diligence and keep SPA mark-ups light in order to appear commercial and willing to do a deal. This approach sometimes works in situations where the buyer knows the target industry or where a transaction makes good financial sense regardless of the detailed legal terms; but in a sustainability-driven transaction financial outcomes aren’t always the primary driver: buyer beware.
Joint ventures
Joint ventures have always suffered from the natural tension that comes with combining different commercial organisations with differing commercial views and objectives. This is often managed through various contractual checks and balances in the shareholders’ agreement, such as reserved matters, controls over budgets and business plans, exit mechanics and detailed provisions relating to future funding. But the rise of sustainability as a strategic driver has begun to cause joint venture partners to see the world differently; putting all of these checks and balances, many of which will have been drawn up before the energy transition and sustainability were relevant issues, under strain.
In some cases this has encouraged those involved in a joint venture to divest their stakes, particularly where this provides a route out of a carbon-intensive industry. Depending on the terms of the JV in question this can leave the remaining JV partners facing the choice of pre-empting the departing shareholder or having to deal with a new JV partner with potentially different motivations and strategic priorities.
For other joint ventures, it is worth considering whether the rise of sustainability has an impact on the contractual terms used to found the joint venture. For example, should there be any reserved matters relating to the company’s climate objectives or its approach to social issues; would a change to B-Corp (or other corporate) status constitute a reserved matter requiring shareholder approval; does the company’s business plan, to be agreed by all joint venture partners, address sustainability issues and sustainability strategy; what kind of finance, green or otherwise, is contemplated? More broadly, are the joint venture partners aligned on sustainability strategy from the outset? And if they aren’t, does it matter?
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