Due diligence, meaning a comprehensive collection and analysis of information about a business before making a transaction, used to primarily focus on how to screen out the “bad guys.” Doing business with institutions such as organized crime or terrorist organizations posed serious risks in both financial and regulatory contexts. And due diligence helps investors and businesses make sure they are not investing their money or their futures with the kinds of organizations that could ruin them. In the modern investing climate, this meaning has expanded.
Due Diligence Meaning: What Does it Involve Today?
Though avoiding the worst elements remains an integral part of due diligence, it’s no longer the entire picture. Business ethics are changing, and due diligence has expanded to include making sure businesses meet ethical requirements as well. Investors, clients and potential partners for mergers and acquisitions are expanding their concept of risk to encompass environmental, social, and governance (ESG) factors. To succeed in this climate, businesses need to be ready to stand out not only in terms of production and innovation but also in the realms of good corporate governance, environmental stewardship and commitment to social issues and community investment.
How Is the Importance of Business Ethics Affecting the Market?
Though ESG considerations in due diligence began in only a small portion of the market, a greater share of investors and portfolio managers alike have begun to see ESG as an integral element when gauging the risk of an investment or merger. In a 2018 survey by the CSA Institute:
- 48 percent of respondents in the Americas answered that governance issues “often” or “always” affected share prices
- 20 percent said environmental issues “often” or “always” affected share prices
- 17 percent said social issues “often” or “always” affected share prices
In the same survey, respondents expected ESG issues to become more important in the coming years for stock shares, corporate bonds, and sovereign debt. Because governance falls closest to traditional concepts of risk and due diligence, it has been the easiest for investors to begin to integrate, while expansion into environmental and social factors has helped add context to risk determinations.
Investment activity reflects this rising interest in ESG. In Q1 2019, inflows into sustainable funds were more than double what they were a year before. And they were more than double in Q1 2020 over the previous year. In addition to investment decisions, this increased attention to ESG applies to the mergers and acquisitions side as well. ESG factors are influencing the choice of:
- Merger and acquisition partners
- The priorities of a due diligence investigation
- Determinations about governance and integration
- Responses by stakeholders to M&A considerations
- Choices by lenders to provide access to capital.
Acquisition prices can suffer when factors such as environmental liabilities or poor labor standards cause an entity to fall short of an acquirer’s ESG standards.
In order to stand out in a market where ESG concerns matter, companies need to take ESG seriously. That includes not only setting goals, but being able to prove to potential investors or M&A partners that they are operating in a way that reflects good corporate governance as well as social and environmental responsibility.
How Can Businesses Communicate their ESG Values?
As interest in business ethics rises, it is important for companies to be able to explain how they are incorporating governance, environmental stewardship, and community investment into their business practices. After all, managing risk related to ESG concerns and clearly communicating how they are doing so raises the confidence of investors and portfolio managers that the company is a good business risk.
In some cases, disclosure of some ESG positioning is even becoming legally required. In the EU, the Sustainable Finance Disclosure Regulation sets rules for disclosing how companies doing business in the EU are facing questions of sustainability, as a way to prevent “greenwashing” – or, conveying false impressions of environmental benefit – as the market for sustainable investment products grows.
There are several ways a company can communicate and highlight how they are fulfilling expectations for business ethics and responsibility. Thirty-five states and Washington D.C. allow companies to structure as Public Benefit Corporations (PBCs). As opposed to other corporate structures, a PBC is allowed to make decisions based not only on the economic interests of shareholders, but also in the interest of a company’s mission, which can be environmental or social in nature. And PBCs must report to stockholders how they are advancing their public benefit purpose. PBCs are becoming big business. Major private companies like Patagonia and Kickstarter are structured as PBCs, and some PBCs such as Laureate Education and Lemonade have successfully gone public.
A company can also consider highlighting its commitment to responsibility by seeking certification as a B Corporation. This is not a different legal business structure but rather a globally recognized certification promulgated by B Lab. Certification as a B Corporation requires verification of social and environmental impact (as determined by the B Impact Assessment), adoption of a legal framework that allows the business to consider and protect its mission, and public transparency with respect to results of its B Impact Assessment.
However, even if a company is not ready to write ESG goals into its legal structure, it is still important to identify and communicate its work toward ESG goals. With increased interest in ethical investing, there has been a problem of inconsistent methodologies for testing commitment to ESG, and a lack of data to rely on that isn’t self-reported. A company can stand out to investors by adopting a clear ESG strategy and performing ongoing due diligence that keeps that strategy in mind.
How IntegrityRisk Can Help
IntegrityRisk has the right approach and expertise to keep your business on the forefront of ESG due diligence. IntegrityRisk developed the ImpactCheck framework to help businesses stay on track with both ESG priorities and due diligence. It is a systematic, analytical approach to ESG. ImpactCheck verifies, validates, and authenticates environmental, social, and governance performance through a comprehensive approach that combines traditional due diligence, investigative assets, data analytics tools, and internationally accepted accounting and reporting standards. This takes you beyond a traditional compliance due diligence checklist, giving you a clear view of how well you align with ESG goals, and putting you in the right position to communicate that clearly to businesses and investors who need to know.
We are here to help you accomplish your ESG goals. Learn more about the ImpactCheck framework, and contact us today for more details about how we can help you make an impact in this world of increasing ESG investing.