Five Ways ESG Will Alter PE-Backed Dealmaking in the Next Five Years
Under the pressure of the global pandemic, the push from shareholder to stakeholder capitalism crystalized. Company scrutiny came not only from traditional institutional investors like insurers, pensions and endowments — but also regulators, employees and a growing groundswell of retail investors. Public companies were held to a new yardstick: producing shareholder value as well as positive impact on people and planet.
While decades in the making, in 2021, the momentum behind Environmental, Social and Governance (ESG) undeniably reached the private markets. One-third of private capital under management is made up of ESG investments, totaling an estimated $3.1 trillion, according to Preqin. Blackstone poached Dr. Jean Rogers, founder of the Sustainability Accounting Standards Board, to oversee ESG for the private equity (PE) giant. The Carlyle Group and CalPERS formed an alliance to measure private company impact. Influential PE firms from TPG to Apollo launched dedicated funds to advance energy transition and decarbonization.
As the largest segment of the global economy, private markets have both the power and potential to change our world. For that potential to be realized, private markets must transition from ESG storytelling to actualizing ESG impact.
Here are five changes we expect to see in the next five years as ESG becomes fundamental to private market mergers and acquisitions (M&A):
Rob Brown, Lincoln International’s Global Chief Executive Officer, shares five ESG-driven changes he expects to impact private market mergers and acquisitions over the next five years.
- Click here to download a printable version of this perspective.
- Sign up to receive Lincoln's perspectives
| Buyers and sellers will incorporate ESG evaluation throughout sale processes
Evaluating a company’s environmental and social impact is complicated by a lack of consensus. Competing measurement frameworks, differing limited partner (LP) values, divergent geographical priorities and industry realities add to the complexity. Against this backdrop, ESG impact is currently in the eye of the beholder.
For this reason, we expect both buyers and sellers to assume responsibility for ESG measurement as part of the sales process in an effort to take control of their ESG narrative. Private companies will pursue valuations which include an assessment of ESG. The question remains whether non-financial data will be incorporated alongside business fundamentals in determining enterprise value — or whether ESG will be carved out as a separate, standalone datapoint for the consideration of buyers who care. With rising concerns of greenwashing, third-party attestation from ratings or valuations providers may become essential for credibility.
Likewise, both private equity and corporate buyers will consider available information, including ESG ratings and company ESG reports when identifying prospective acquisition targets. During the due diligence phase, sponsors will ensure that ESG claims are accurate and align with their stakeholder values.
|General Partners (GPs) will voluntarily report out ESG performance to LPs
Last month the Securities and Exchange Commission proposed disclosure rules for private company financial data — reflecting a growing trend toward transparency in the private markets. Many PE firms have already begun the process of voluntarily collecting ESG data from their portfolio companies on an annual basis. As PE hires ESG experts and tracks their portfolio impact, we expect to see both fund-and-company-level ESG reporting become expected and standardized — with the ability for investors to meaningfully benchmark against private and public company comparables. Once regular reporting becomes the norm, we expect LPs to align their future capital allocation to fund managers who demonstrate the ability to both deliver ESG impact and healthy financial returns.
|Private markets will reach consensus around an ESG measurement framework
The lack of consensus behind ESG measurement frameworks creates headaches for LPs and lenders. While GPs may continue to advocate for customized (or, as critics will label it, “cherry-picked”) ESG measurement, we expect the industry to rally behind a single framework for measurement within the next several years.
Already, certain goals are transcending geography and industry, such as reaching net zero emissions. Evolving official and unofficial regulatory pressures, such as the European Union’s Sustainable Finance Disclosure Regulation, may also drive consensus.
|More PE firms will launch dedicated impact funds
Dedicated impact funds make it easier for GPs to align investment mandates to LPs with a stated interest in ESG investment, and seek lenders focused on green credit. As LPs come under scrutiny to deploy capital responsibly, pressure from asset owners on the PE industry is expected to increase.
Beyond the moral imperative, we expect impact funds to continue to build in popularity due to a compelling investor rationale: outperformance. While more data is needed to demonstrate return of ESG investments, GIIN’s 2020 Impact Investor Survey found that 86% of PE impact investors reported performing in line with or exceeding their financial performance expectations.
|Longer hold times will lead to more sustainable private market outcomes
One of the greatest challenges that private equity has in creating ESG impact for their portfolio companies is the short time horizon of investments. We expect the rise of continuation funds and growing private equity appetite for longer hold times on attractive investments to allow for more thorough and practical ESG goal setting and realization.
The private equity playbook for value creation is clearly evolving to include environmental responsibility, economic opportunity and diverse representation. This is a chance for the industry to demonstrate the power and potential of private markets to create more than financial value.
Meet Professionals with Complementary Expertise in M&A
I am enthusiastic about creating sustainable growth and the highest value for our clients, and strive to leave a positive footprint beyond any successful M&A transaction.
Managing Director | Management Board MemberFrankfurt
I enjoy leading clients and realizing their objectives, while structuring solutions to issues that are both intriguing and challenging.
Managing Director | Head of SwitzerlandZurich
I am inspired by working with entrepreneurs and innovators who feel passionately about what they are creating.
Managing DirectorSan Francisco
Related Perspectives in M&A
Cybersecurity Report: Q2 2023
Consecutive quarterly sector mergers and acquisitions (M&A) deal activity rose in Q2 2023 to 54 cybersecurity transactions, from 49 in Q1 2023. Q2 M&A volume of $2.4 billion was roughly… Read More
HealthInvestor | CMA Launches Review of Vet Sector
Originally posted by HealthInvestor on September 7, 2023. The Competition and Markets Authority (CMA) has begun reviewing UK veterinary services to uncover how well the market is working for pet… Read More
Real Deals | Finding Opportunities Amid Uncertainty
Originally posted by Real Deals on September 1, 2023. European deal activity in the first half of 2023 has been slower, but activity in the second half of the year… Read More
Conceiving Success: Growth and Consolidation in IVF in APAC and the Middle East
In-vitro fertilization in Asia-Pacific and the Middle East is growing quickly due to several factors; the industry’s rapid growth offers an opportunity for investors to capitalize on momentum. In a… Read More
Recent Transactions in M&A
Lincoln International advised EV Private Equity on the sale of Bluware to Computer Modelling Group
Lincoln International advised The Beekman Group on the sale of GED Integrated Solutions to MSouth Equity Partners
Lincoln International advised Havencrest Capital Management on its majority investment in Tekton Research
Lincoln International advised Mutares on the sale of Special Melted Products to Cogne Accial Speciali, a subsidiary of Walsin Lihwa
Lincoln International advised Chequers Capital on its agreement to acquire Cheops from Indufin
Lincoln International advised Your Way Medicare on its sale to Accretive, a portfolio company of GTCR
Lincoln International advised Industrial Growth Partners on the sale of Des-Case Corporation to The Timken Company
Lincoln International advised e-Attestations on its sale of a minority stake to Keensight Capital