ESG Impact on Private Equity Transactions

Environmental, Social and Governance (ESG) factors have become a major concern at the European and international levels. Tackling sustainability is now a business imperative, but how exactly can ESG create value?

As authorities are requiring companies to disclose ESG related information and stakeholders are growingly seeking to invest in companies with strong ESG standards, managers are asking: how can ESG factors also increment my company’s value? 

Here are five powerful ways ESG can boost cash flows and company value:

1. Market Growth: ESG compliance can increase a competitive edge when trying to enter into new markets or develop in existing ones;
2. Cost Efficiency: Implementing sustainable practices can reduce operational expenses, such as the cost of raw materials, driving efficiency;
3. Risk Mitigation: Proactively managing ESG risks can protect companies from fines, legal issues and reputational damage
4. Employee Productivity: Employees who find purpose and social value in their work are more satisfied and productive;
5. Smart Investment: Avoiding investments that might not succeed in a longer term and focusing on promising, long term sustainable opportunities can optimize capital allocation.

The private equity sector, in its twofold relationship with investors (fundraising) and target companies (sourcing), is particularly sensitive to the benefits of investment optimization brought by ESG factors. Investors’ attention to sustainability matters seems to be stronger than ever, hence private equity firms should make sure that they offer investment opportunities that align with the market’s expectations. This is vital since private equity investments often span 5 to 10 years, a period during which poor ESG practices can significantly impact the business’s attractiveness for prospective buyers. This involves a shift from a negative screening approach, based on the exclusion of companies operating in certain sectors (e.g. weapons, alcohol, tobacco), to a positive screening method, which is more focused on identifying specific ESG attributes, which is achieved through the use of checklist questionnaires and opinions by ad hoc ESG advisors.

Both investors and private equity companies are actively seeking new opportunities for ESG-friendlier investments. In this context, Luxembourg is continuously expanding its toolbox of ESG-friendly projects and initiatives, including initiatives by the EIB Climate Finance Platform, the Luxembourg Sustainable Finance Initiative and by the Luxembourg Green Exchange, with the aim of promoting a more sustainable global economy and supporting responsible investment funds.

This article first appeared in the "Paperjam July 2024, ESG supplement".