ESG Due Diligence: Common Challenges and Solutions

While there are many advantages to integrating ESG considerations in M&A transactions, the aim of incorporating these matters in due diligence processes is not without its challenges.

Incomplete and Unquantifiable Data

One of the most significant challenges is that the target company may not be able to provide the potential buyer with accurate and comprehensive ESG-related data. This is particularly common when the target is a smaller private company that has not actively developed its ESG performance. When ESG information is incomplete or difficult to quantify, the buyer’s advisors may recommend further investigation and suggest that hidden risks be factored into negotiations. However, this situation entails that advisors cannot offer a thorough and quantified assessment of the company’s ESG track record. As a result, it becomes challenging to provide clear and actionable recommendations. In these cases, a potential buyer may choose to conduct more comprehensive site visits as well as interview representatives and key personnel of the target company. The advisors can assist the client by presenting publicly available ESG data regarding comparable companies to provide a reference point concerning which issues are more likely to be present in the target company.

Absence of Standardised Market Practice

Another ongoing challenge is the lack of a consistent, market-wide standard for what ESG due diligence should include. ESG is a broad and evolving concept, encompassing a wide range of topics, which makes it difficult for parties to agree on the appropriate scope of review. As a result, parties may enter negotiations with differing expectations about which ESG issues should be examined and how thoroughly. This misalignment can result in delays, disagreements, and overlooked risks. Despite ESG’s growing prominence over the past decade, there is still no concrete consensus on what constitutes a comprehensive or sufficient ESG review, and this may also vary depending on the size of the company or the nature of its business. Until a market standard develops, these challenges are likely to persist. However, experienced advisors can mitigate these issues by implementing clear ESG due diligence protocols early in the transaction process and facilitating upfront dialogue to align expectations on scope and methodology.

Quantifying the Financial Impact

A third challenge lies in quantifying the financial impact of ESG-related risks and opportunities. Unlike traditional financial metrics with established methodologies, ESG factors often involve long-term or non-financial outcomes that are difficult to translate into monetary terms. Environmental risks, such as exposure to climate change, may unfold over decades, and social initiatives like employee wellbeing programs may generate intangible benefits without clear financial benchmarks. This complexity can lead to disputes between the parties over how to adjust for ESG-related risks in pricing, warranties, or other contractual terms. The absence of agreed valuation models for ESG risks further complicates matters by increasing the likelihood of overestimating or underestimating their material impact. Professional advisors can address this challenge by engaging with industry specialists to develop tailored ESG valuation approaches. By using tools such as scenario planning and sector-specific risk analysis, they help ensure that ESG factors are more accurately reflected in transaction pricing.

Managing Challenges for Competitive Advantage

While the challenges associated with ESG due diligence are numerous and complex, they are entirely manageable with appropriate expertise and strategic planning. With the right advisory support, ESG due diligence can transform from a compliance burden into a competitive advantage that drives transaction success and long-term value creation.