Sustainable M&A - legal aspects

‍The basics

How can M&A be 𝘴𝘶𝘴𝘵𝘢𝘪𝘯𝘢𝘣𝘭𝘦?

Three examples:

An investor uses an M&A project specifically to transform a target company - from a problem case (with a favorable purchase opportunity) to an attractive, sustainable asset (with strong potential for value appreciation).
A buyer uses an M&A project specifically to transform the buyer group itself through the target company - from a classic old economy medium-sized company to a sustainably positioned company.
An M&A project creates sustainable added value for the company - beyond the pure financial upside.
An important question to ask at the outset: is there a sound reason for not putting sustainability at the top of the agenda in a transaction?

The buyer should ask this question because sustainability risks can not only have negative financial consequences, but also significant negative reputational consequences. For example, an investor should not run into an incalculable publicity storm.

The seller should understand that sustainability risks can mean considerable reductions in the purchase price.

Conversely, a clean sustainability strategy also means reputational upside (on the buyer's side) and purchase price potential (on the seller's side).

I like the following definition: "Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs."

(International Institute for Sustainable Development)

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Non-ESG

But why might it also be appropriate not to prioritize sustainability in the transaction process?

There may be certain business models in which these issues are structurally uncritical: smaller service providers, software companies or manageable business models in the healthcare sector may be less susceptible to sustainability risks.

On the other hand, the CO2 footprint and supply chain are also quickly on the table here. And even if legal thresholds (e.g. Supply Chain Act) are not met - just one important major customer demanding compliance with these requirements from its suppliers is enough.

In many cases, we therefore see the need to take sustainability seriously. But how exactly?

1. Clean definition of the transaction perimeter
2. Clean planning and execution of due diligence
3. Clean contract documentation

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Transaction perimeter

If it is clear that the target company's business model contains critical elements in the area of sustainability, it is always worth considering defining the transaction perimeter accordingly.

For example, it would be conceivable not to include certain assets, subsidiaries or even parts of the business that are critical in the transaction in the first place. This could be implemented through a targeted restructuring before the transaction is concluded, or at least before it is completed.

Technically, the SPA would then have to stipulate that the critical assets, subsidiaries or business units have been “separated” from the target company as a condition for completion. It is conceivable that this requirement could be brought forward as a “condition to signing” if the seller is prepared to do so or the buyer has the negotiating power to do so.

This “separation” will regularly be structured as an asset deal; a restructuring in accordance with the Transformation Act is also conceivable, particularly in the case of partial operations. From the buyer's perspective, these measures should be closely monitored and examined on the seller's side, in particular in order to identify risks and allocate them to the seller's side. For example, a stable indemnification of the target company for risks in connection with the critical assets should be provided for in the asset deal.

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Due Diligence

When considering sustainability in due diligence, three main questions need to be answered:

1. Part of the traditional DD streams (legal, financial, commercial) or a separate DD stream?

2. which specific topics should be included in the DD?

3. which standards should be applied to the individual sustainability risks?

There are many sustainability-related issues in the legal DD stream in particular: Compliance with the Supply Chain Act, for example, the fulfillment of mandatory reporting standards, existing litigation. However, there are also relevant non-legal items, such as diversity, inclusion and greenwashing. The decision for a separate DD stream is primarily determined by the exposure of the target company: are there significant risks here, e.g. because the target company is active in critical industries or countries? If so, a separate DD is essential - as is proper dovetailing with the other DD streams, especially the legal stream.

If risks are primarily of a legal nature, the benchmarks for risk assessment are clear: the violation of a law can, for example, generate risks of fines for the target company (and possibly the entire group of buyers) or costs to remedy the violation and compensation for damages.

If risks can be assessed on the basis of clear KPIs, particularly in the case of carbon footprint issues, it is easy to quantify the risk on the basis of a benchmark.

However, if the risks are not of a strictly legal nature and there are no KPIs with benchmarks, e.g. non-compliance with a voluntary commitment, lack of equal pay, greenwashing, the standards for measuring the risks are much more difficult, precisely because reputational risks are often involved here. If significant risks become apparent, an attempt must be made to substantiate them using mathematical methods.

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Documentation

Sustainability risks identified in the DD must then be mitigated in the contract documentation, especially in the SPA.

The classic instruments available are guarantees, indemnities and closing conditions (in conjunction with covenants). These regulations serve primarily to eliminate a risk and sanction the seller: the seller must bear the cost of eliminating a risk, either before completion by fulfilling a closing condition or after completion in the case of a guarantee or exemption.

Conversely, incentivizing provisions are also conceivable: the seller can be granted an earn-out if certain sustainability target KPIs are achieved. It is also conceivable to grant a reverse participation with a put option for the seller to participate in an increase in value in the event of positive sustainability development of the target company after the transaction.

Especially in the case of particularly critical business models or a critical history of the target, the period between signing and closing should also be contractually secured in a stable manner. From the buyer's perspective, sustainability MAC clauses are particularly suitable here, but also bring down obligations to the closing date.

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Sustainability is created through cooperation

Why is sustainability created through cooperation?

Because no one wins alone. Sustainability is created by pooling all resources, because this is the only way to positively transform the economy together. Such a breakthrough often occurs when established companies cooperate with young, specialized companies. This creates the opportunity to combine existing know-how with dynamic approaches.

These cooperations take many different forms. For example, a family-owned company that establishes a joint venture with a start-up in order to reduce its carbon footprint or corporates that find targeted access to sustainability innovators through green venture capital investments. On the investor side, we see cooperation with entrepreneurs who, for example, build a buy & build platform to invest in the circular economy.

The following three aspects are particularly striking for successful cooperation models:

C Level Attention: for sustainable transformation to actually succeed, C Level Attention is needed. CEOs negotiate with founders, not specialist departments with developers.
Robust structures: legally and fiscally robust structures are designed from the outset in order to avoid blockages later on, e.g. due to ill-conceived governance.
Do: Ultimately, the most important thing is to be aware of the challenges and actually have the courage to face them. So it's all about getting started, tackling and implementing together.

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