Insight

ESG: Getting serious about ESG

As the financial benefits become clear, PE firms are prioritizing ESG and assessing these factors earlier in the deal cycle.

Mark Golovcsenko

Mark Golovcsenko

Principal, ESG Strategy Leader, KPMG US

+1 212-954-2373

In 2021, ESG became a top priority for PE firms. Like institutional shareholders in public companies, PE limited partners are pushing funds to step up efforts to address environmental, social, and governance issues. There is growing belief that companies with strong ESG scores will command a premium.8

ESG has thus become a factor in how funds evaluate assets and how they manage portfolio companies. And, like other managers, PE executives are developing ESG skills so they can turn ESG from a compliance burden to an opportunity to create value. More and more PE funds are addressing ESG earlier in the investment lifecycle (see chart).

When during the deal cycle do you first evaluate ESG considerations?
% of global respondents, n=95

Source: KPMG U.K.


Pre-deal:

Incorporating ESG principles into deal evaluation and due diligence

  • PE firms are increasingly incorporating ESG into every due diligence, using as a minimum risk-management and value-preservation lenses to evaluate publicly available and target-provided data.
  • During diligence, leading PE firms are supplementing the available data with “outside-in” analyses premised on estimating a target’s greenhouse gases baseline, comparing a target’s
    emission profile to peers, constructing an estimated ESG rating, assessing the impact and potential cost of climate change on a target’s operations, and creating a forward-looking assessment of how changes—regulation, technology, market demand, others—impact the business.
  • PE firms with more advanced capabilities are not only assessing a target’s ESG profile but also mapping postclose ESG opportunities. Examples include: deconstructing a target’s ESG rating to identify levers to pull; employing analytics to get under the covers of a target’s DEI profile—going beyond diversity “snapshots” (i.e., share of employees in various diversity categories) to better “equity,” and “inclusion” measures—in order to identify high-leverage opportunities to drive improvements; and assessing a target’s decarbonization plan to accelerate high ROI opportunities (e.g., renewable power purchase agreements).

Tenure:

Incorporating ESG into value-creation plans

  • Once a targeted asset becomes part of its portfolio, the PE firm may continue to ramp up the acquisition’s ESG efforts. These typically involve streamlined ESG materiality assessments, baseline emissions measurements, climate-risk assessments of the asset and its supply chain, ESG target setting, and standing up ESG programs.
  • PE firms can also take a value-creation approach across the portfolio, which may contain businesses that are not yet advancing on ESG. By improving ESG performance, PE owners can increase valuation and make these assets more attractive to potential buyers, who may be shopping for
    ESG-enhancing businesses. 

Exit:

Using ESG to enhance the exit story and achieve higher multiples

  • As they prepare assets for sale, some PE firms are providing ESG reports to speed up the sales process, signal to ESG-oriented buyers, and maximize value. Some PE-held firms preparing for an exit via an IPO are also touting a credible ESG focus and track record as key differentiators as investors shift more dollars to sustainability plays.

In 2022, we expect more and more organizations will look for ways to create value through ESG efforts. Like corporates, PE firms now have no choice but to deal with ESG head-on. But PE firms that develop strong ESG-management capabilities and embed ESG into every phase of the investment cycle—and into the strategies of portfolio companies—can earn an ESG premium.

Footnotes

  1. Source: Harvard Law School Forum on Corporate Governance, “ESG Matters,” January 14, 2020 .