There seems little doubt that ESG considerations will continue to grow for all businesses, large or small. With growing awareness of climate change and depleting natural resources alongside wider social issues of ethics, inclusion and inequality, businesses are being driven to seriously consider their stance on ESG. Our latest ‘5 minutes with Corporate Finance’ article explains why you should make reviewing your company’s ESG policy a priority.
What is ESG?
ESG (Environmental, Social and Governance) policies and procedures are established within a business to help drive the right strategy and behaviours regarding environmental and ethical practices. In turn, these measures can often enhance the perceived value of a business in the eyes of its customers, employees and wider stakeholders.
The ‘environmental’ element of ESG can be far reaching dependent on the particular business but can incorporate issues such as energy use, vehicle fleet management, supply chain auditing and product design. Whilst in many of these areas such considerations are voluntary, there is also a growing raft of regulation and reporting requirements created to force businesses to operate in a suitably sustainable way.
The ‘social’ and ‘governance’ elements operate to drive high ethical standards, which protect both a business’ employees and those other organisations and authorities that it interacts with.
Taken together, a strong ESG stance can be a powerful tool for your business if you are looking to differentiate your company from more blinkered competitors.
ESG investment and its priority for businesses today
Concerns around ESG are growing in the SME market as consumer awareness continues to develop, and investor and supply chain pressures facing listed companies begin to cascade down the supply chain.
As a result, investment in ESG has been rising at pace and this shows no signs of slowing down. Research by Aldermore Bank found that UK SMEs invested an average of £61,250 in sustainability initiatives during 2022. Their research also showed that the average SME plans to dedicate a further 27% to their sustainability spend in 2023.
However, the ongoing macro-economic pressures including the war in Ukraine, increased energy costs, and inflated raw material prices could inhibit continuing investment in ESG for smaller businesses. British Business Bank’s SME Finance Survey 2022, which interviewed over two thousand SMEs across the UK between October 2022 and January 2023, outlined that 67% of the SMEs surveyed selected the ‘current economic climate’ as the biggest obstacle to becoming more sustainable.
As SME owners grapple with the challenges of the current economic climate, there is a risk that investment in ESG will be given a lower priority, which could prove to be a costly short-sighted decision.
ESG policies and strategies should be viewed as an investment in the future of a business. Deferring such investment will of course protect a business’ cash flow in the near-term, but inherent inefficiencies and sustainability challenges within the business are likely to persist without such ESG investment.
Whilst some SMEs have reprioritised away from investment in sustainability as inflationary headwinds have taken hold, others have continued to plan and proactively invest in such measures. The SME Finance Survey 2022 found that 46% of surveyed SMEs placed environmental sustainability as a high priority throughout 2023.
The business case for investing in sustainability too often focuses on risk, while overlooking the benefits and opportunities for growth.
Given the relative scale of SMEs, small investments in sustainability measures and practices can have substantial positive impacts. Whether it is promoting workforce diversity or establishing a ‘greener’ supply chain, ESG considerations look set to become a core component of long-term viability of SMEs in the UK.
How does ESG create value?
There are a number of specific ways in which investment in ESG can create value for SMEs, some of which are outlined below:
- A focus on sustainability will attract new eco-conscious customers. Demonstrated sustainability credentials can help to boost a business’ reputation and increase its brand awareness, both of which are key to driving sales growth.
- General awareness of ESG may be growing, but for many businesses it remains embryonic so early mover advantage presents a generational opportunity to stand out from the competition.
- ESG can lower a business’ costs in several areas – for example, a business with manufacturing processes that are less reliant on fossil fuels will be more resilient to energy price fluctuations. Sustainable practices can also mean better resource allocation and reduced waste storage and processing costs.
- People focused ESG investment can support staff retention and contribute to a more engaged workforce, which in turn can lead to greater motivation and operational efficiency.
- Ongoing investment in sustainability supports the development of new processes, products and markets. This helps to drive innovation and creates efficiencies that will ultimately support reliable, long-term growth.
- Investment now will better prepare businesses for inevitable changes to ESG regulations and requirements in the future.
Through investment in ESG, sellers therefore have an excellent opportunity to strengthen their business’ operations and enhance value.
With more resilient profit margins, greater employee engagement and long-term operational efficiencies, it is also clear that investment in ESG and sustainability can make SMEs a more attractive investment proposition for buyers.
Key ESG considerations for buyers
In any business sale process, a buyer will look to ensure that the target’s procedures and operations are thoroughly understood and ESG considerations are forming an increasingly important part of this due diligence exercise.
There are several sustainability-related factors that a buyer will consider throughout any deal process including:
- First and foremost, what ESG strategies does the target have in place?
- Does the target’s ESG policies align with the buyer’s own policies? If not, can the target efficiently and effectively integrate these into a single coherent strategy over time?
- Has the target incurred any ESG related liabilities (e.g. fines) in the past? If so, has there been any reputational damage as a result, and has the target taken appropriate remedial action to mitigate potential future breaches/liabilities?
From an acquirer’s perspective, both trade and investor buyers are already placing an increased focus on ESG when appraising and valuing a target. This inevitably leads to certain subjective assessments when ESG measures do not directly translate into a discrete financial return. There is an evolving ‘scorecard’ approach developing and certain forward thinking companies have attained certified ‘B Corporation’ status as a badge of their ESG credentials.
The future proofing starts now
Whilst it is natural for business owners to exercise caution under the current economic conditions, it is important that you remain aware of ongoing ESG trends and are constantly thinking about your long-term goals.
Cutbacks may seem like a solution to mounting financial pressures in the short-term, but they are likely to impact your future growth, and delay the recognition of key operational efficiencies.
The importance of sustainability will only increase with time and it is a matter of ‘when’ not ‘if’ regulations will be introduced surrounding corporate responsibility.
Investing sooner rather than later could present opportunities to develop competitive advantages, as well as drive innovation and strengthen brand reputation. Whether you are a buyer or a seller, considering the impact of ESG will be key to future proofing your business.
If you are looking to acquire a business or would like more specialist advice on a business disposal, contact us today to speak to our expert PKF Smith Cooper Corporate Finance team, winners of ‘SME Advisory Team of the Year’ at the Insider Media Midlands Dealmakers Awards 2022.
PKF was at the forefront of a record-breaking year for dealmaking in the Midlands in 2022 as the 7th most active M&A advisers in the region and our team is looking forward to building on this momentum throughout 2023.