Guidance, advice and tools on dealing with ESG matters at the exit stage.
Click on the chevrons below to go through each of the stages in the investment cycle.
Why ESG factors should be considered when planning for a successful exit
Fund managers and companies should understand ESG aspects that may be important at exit, in order to:
An overview of the exit stage is shown in the graphic below.
2.1 Plan the exit
It is likely that exit considerations will contribute significantly to strategic decisions on ESG matters throughout the investment’s holding period. For example:
Nearing the end of the investment term, fund managers should review any material ESG issues to ensure there is sufficient time to address any potential problems. Holistic preparatory work, irrespective of the specific exit strategy, may help to maximise company value. This may be particularly valuable for investments held for a long time, where due diligence (DD) at acquisition is unlikely to have matched current best practice. In such circumstances, a detailed vendor-audit or review may be necessary. However, where adequate on-going portfolio engagement and ESG performance review has been encouraged, this may merely require collation of up-to-date information in an appropriate format.
The original acquisition due diligence (DD) report can serve as a baseline against which improvements (or otherwise) in ESG performance can be effectively assessed. On exit, a high-level review may be pertinent to identify ‘lessons learned’, both positive and negative. This can help to inform a fund manager’s wider ESG strategy, policies and procedures. Regular ESG reports prepared during the lifespan of the investment may also be a source of valuable information during the exit process.
Fund managers should share relevant ESG information with potential bidders, and be prepared to address any questions in relation to the company’s ESG performance.
The strategy for dealing with ESG issues will be determined in part by the fund manager’s chosen method of exit. For example, the level of data presented by the fund manager may vary if pursuing an initial public offering (IPO) or secondary exit.
Some buyers will not value ESG improvements unless the benefits are clearly laid out. It is important to show that ESG systems are in place as part of broader evidence of high-quality management. The company should not be afraid to discuss the areas it is still working on, as knowing where and what its challenges are can put it ahead of peers and be reassuring for new investors.
There are also buyers for whom good ESG management systems are a pre-requisite, or a stated wish, in order for them to invest in a company. These include the growing number of private equity funds with ESG policies, Development Finance Institutions (DFIs), and multinational trade buyers with global standards (who are concerned about the amount of work that may be required to bring the business in line with their corporate policies and procedures). Acquirers may also be concerned about legal liabilities or reputational risks associated with investing in/buying companies in emerging markets that may have unresolved ESG issues (e.g. contaminated land or community unrest issues). Actively demonstrating that these risks are effectively managed should ensure that the maximum number of exit options are available to the fund manager. This might include:
Public flotation (initial public offering)
Initial public offerings (IPOs) come with associated listing requirements, public scrutiny and reporting, stakeholder pressure and increased need for transparency. Hence there are usually demands from ESG conscientious investors. As a result fund managers should prepare detailed disclosures when considering an IPO, and should be ready to:
Key outputs at this stage include:
Typically, fund managers prepare a detailed financial model to arrive at a valuation when selling its portion of the company. The way ESG aspects were managed during the holding period will affect such a valuation. In many cases, focused management of ESG aspects will have enhanced the business and contributed to improved margins and reduced risks.
The following ESG documentation may be used to develop and justify the financial model:
Many fund managers have found that including tangible evidence of improved ESG performance in the information memorandum has better positioned the company to prospective buyers and enhanced its value. Tangible evidence may include access to new markets, growth in sales, or reduced operating expenditure due to waste minimisation.
In many cases, the prospective buyer will require a warranty from the fund manager related to ESG claims. A good track record and market reputation by the company due to good ESG performance can bring comfort to prospective buyers that such claims are unlikely.