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Buy-side or Sell-side, Quantifying ESG Risks and Opportunities Creates Value in 2023 and Beyond

Posted: January 19th, 2023

Authors: Connie P.  Bill S. 

When asked the question, “What factors impact my company’s value?”, the historical response from the C-suite would focus on the business fundamentals of the company: predicted growth and margin, cash distributions to shareholders, debt-to-equity ratios, and economic conditions and volatility in the space to name a few.  While these fundamentals continue to have a significant impact on value, a company’s exposure around sustainability and environmental, social, and governance (ESG) is becoming increasingly important for investors when they analyze the companies in which they look to invest.  Whether you find yourself on the buy-side or sell-side of transactions, a well-devised ESG strategy and execution process can mitigate risk and reveal opportunities.

For the sell-side it begins with a livable ESG strategy.  The strategy must begin with the C-Suite. The G in ESG is about ensuring that processes, consequences, and incentives are in place to guarantee an engaged C-suite.  Engagement of the C-suite is critical as you look to curate an impactful strategy. Next, understanding where your company currently stands in its ESG journey compared to peers and relative to market pressures will help inform an effective strategy.  The ESG strategy, however, can be very specific to a company’s vision and culture.  Formulating an ESG strategy that aligns with your company’s vision and culture accelerates adoption and integration into the business model.  When the strategy becomes part of the business model of a company, and is powered by executive engagement, the strategy can withstand scrutiny and demonstrate authentic risk management and competitive advantage.

Patagonia immediately comes to mind as a company that has thoughtfully and intentionally integrated their ESG strategy, business strategy, and investor strategy.  Whether it’s Patagonia’s self-imposed “Earth Tax” that they define as “1% for the Planet” to support environmental nonprofits; Yvon Chouinard’s decision in September, 2022 to transfer the ownership of Patagonia to a specifically designed trust and nonprofit organization; or their decision to shut down all North American stores, customer service operations, and warehouses between December 25 through January 1 because they “believe in providing quality of life for our people”; Patagonia clearly has incorporated sustainability and ESG into their business model and have since the company was founded.  We recognize that Patagonia’s approach may be aspirational, or maybe even out of reach for some companies, but the commitment to integrate ESG strategy with their business and investor strategy is an example and inspiration for all.

Implementing an ESG Strategy means identifying metrics, and tracking/reporting progress.  Once an ESG strategy is developed, an effective data strategy is a key step to developing clarity around your ESG program so that you can articulate and quantify your material risks and opportunities to the investor community.  Most investors want to see and understand data to help them inform their decision-making.  Most ESG metrics are data intensive. Therefore, a solid digital platform populated with accurate data is key to disclosing metrics and reporting information that is defensible and meaningful to your stakeholders. Having data that tells a great story about how your company is addressing ESG risk gives your organization a stronger valuation relative to peers who are not prepared to answer hard questions about these complex issues. Meanwhile, investors need to be prepared to ask these hard questions in keeping with their fiduciary duty to their beneficiaries. An investor should have an understanding of ESG risks common to particular industry verticals and specific to their portfolio companies and targets.

ALL4 is currently working with a client to develop a portfolio of documentation that addresses risks related to climate, biodiversity, human rights, and environmental impacts. This portfolio, developed according to the Equator Principles, will be shared with potential investors to demonstrate that the organization is aware of, and addressing, those risks. 137 financial institutions in 38 countries have adopted the Equator Principles because they wish to confront risks related to ESG metrics when making investment decisions and the traditional investment due-diligence protocols fell short. Those seeking to partner with financial institutions find benefit in the discipline and effort required to satisfy the principles because doing so increases valuation and gives access to better deal terms and capital.

Not everyone is so advanced in their ESG journey. Another client we are working with has just begun to understand their risks and material issues across the value chain. With this client we have developed a materiality assessment to define and prioritize the most critical ESG threats and opportunities to their business. Other clients have defined material issues and we are helping them to quantify exposure with defensible data such as developing Scope 1, 2, and 3 emissions inventories or reaching through their supply chain to collect information.

ESG data availability and integrity will unlock access to capital and incentives.  The Securities and Exchange Commission (SEC) proposed amendments in 2022 to rules and reporting requiring disclosure of Scope 1 & 2 GHG emissions for most issuers to promote consistent, comparable, and reliable information for investors concerning ESG factors.  Many large purchasers are requiring CDP disclosures in order for qualifying vendors to be eligible for contracts, including Microsoft, Walmart and, at time of press, the U.S. Government.

The Inflation Reduction Act of 2022 (IRA) aims to reduce U.S. greenhouse gas (GHG) emissions by 40% from 2005 levels by 2030.  To achieve this goal there are tax credits, grants and other incentives available to companies who invest in technologies, products, and services that have positive implications for climate change mitigation and adaptation.

These are just some of the market drivers that will require companies to focus on the availability of ESG data and the quality of the data.  Companies are being expected to better manage and disclose ESG data and the timeliness, accuracy, and consistency of these data will be scrutinized like never before.

For one ALL4 client, annual ESG data that was previously compiled in May and June for reporting to CDP (i.e., after the traditional environmental compliance reporting time periods), is now being required to be compiled by the end of January for the prior year. This shortened time frame is being driven by the investment community and may become standard with the finalization of the SEC amendments.  The ability to provide timely, reproducible, accurate data consistently across multiple facilities and various information management systems will be critical in the eyes of the investment community.

ESG as a business fundamental in determining a company’s value.  Customers, employees, and the investment community are signaling that ESG performance is a key consideration when it comes to purchasing goods and services from companies, choosing to work at companies whose values and vision align with personal values, and/or investing financial resources in companies.

John Nies, JMH Capital Managing Partner, recently shared, “There has been a seismic shift in the business community, and a rapid acceleration in the past two years in how ESG performance is affecting a company’s access to capital and the associated cost of that capital.  This fundamental shift is driven by the sophistication of investors, each with their own ESG goals and priorities, and the clear mandate from the market that their investment dollars must consider a company’s ESG behavior and their ESG metric reporting.”

Think about and create your company’s ESG strategy; plan, execute, track progress, and report your ESG metrics; and ensure that your underlying systems and processes can withstand the review and scrutiny that ESG metrics will be subject to.  By effectively managing your company’s ESG performance, you will directly impact a risk – a fundamental element of any company’s performance and valuation.

Please feel free to reach out to Bill Straub, ALL4 CEO, wstraub@all4inc.com with questions about what investors should be looking for related to ESG risks and opportunities. For help preparing your company to address and communicate ESG risks and opportunities please contact Connie Prostko-Bell, ESG & Sustainability Practice Director at cprostko-bell@all4inc.com.


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