Considering Green M&A Provisions in Ordinary M&A Transactions

Considering Green M&A provisions in ordinary M&A transactions

By Leo Rifkind.*

The objectives of M&A are typically derived from combined economic growth: gaining from economies of scale, synergies, access to new markets, sharing of products or facing up to increased competition. Meanwhile, both public and private institutions are acknowledging the importance of environmental, social and governance objectives to long-term value, including major private equity houses creating green only impact investment funds and advisories.

Private equity transaction purchase agreements currently play, among other things, a dual role for the buyer and seller to allocate risk between each other, but also to seek to incentivise the parties (and often management) to work together for the financial success of the sale (certainty of the transaction, minimise liability, ensure conditions are met, etc.) and of the business going forward (so the business can be stable post-acquisition).

However, in view of other areas of corporate law and financial regulation starting to open their wingspan to non-monetary targets as measures of success, such as the statutory recognition of the broader remit of acting in the best interests of the company going beyond pure shareholder value, the emphasis on corporate governance by boards, and incoming industry standards focused on environmental, social and governance monitoring and reporting practices, buyers and sellers could begin to use transaction agreements and post-transaction arrangements, as the building block of the new combined business, to seek to tackle environmental goals pre-acquisition in traditionally non-environmental businesses, such as in terms of energy and water consumption, carbon footprint, solid waste and wastewater disposal and other environmental concerns that derive from the target business.

One way to achieve this could be through the transaction purchase agreement itself. By a buyer using due diligence, using existing frameworks such as the Principles for Responsible Investment, or agreeing with the seller to appoint an environmental consultant, to propose a list of environmental targets to be achieved between signing and closing that result in the buyer acquiring a business with greater long-term value (directly attributed to achieving the environmental targets set and provided that the long-term value exceeds the short-term cost input) and the seller being able to relay to its investors that, in addition to achieving its economic sale objectives, it has also achieved environmental objectives without harming the economics.

By way of example, if a buyer sought to acquire a number of hyper scale data centres across Europe from a seller (total proposed consideration of say, $1bn, for the current business), one important concern to the buyer might be that there is sufficient and competitive power being provided to each hyper scale data centre. If such power source is dependent upon a particular relationship with a particular coal power plant that risks being closed by changing political attitudes and incoming legislation, the long-term value of the dependent hyper scale data centres could be jeopardised (and say, this risk is priced into the $1bn by the buyer as -$50m, representing the anticipated cost of the delay in replacing the power source).

If the buyer and the seller instead agree that the transaction will only close subject to such power source being replaced between signing and closing with an environmentally acceptable alternative (say, at a cost of $10m), where such costs are to be shared equally by both parties, ($5m each), the value of the business may be greater for the buyer than the sum of the combined required investment (in this case, $1.01bn (sum of required investment) vs. $1.05bn (value of the business to the buyer without the environmental risk)) and, as a result, the seller may be able to justify greater sale consideration. Further, the parties could agree that the seller’s contribution could be set-off from the purchase price so there are not additional concerns with respect to liquidity.

A more interventionist approach might explore the case for a new government regulator, an environmental regulatory authority, that operates similarly to a competition authority and requires notification and/or consultation with respect to the environmental objectives of the target business prior to the closing of transaction and potentially its consent to close the transaction. As we are seeing with incoming foreign investment regulators, including in the UK, some consider this an effective mechanism to control what M&A is deemed acceptable. However, unlike mitigating anti-trust or foreign investment concerns, achieving environmental objectives as part of a transaction can benefit both buyers and sellers both socially and economically and therefore may not necessarily need public intervention in the same way that competition law might do to require adherence to its objectives. In addition, such positive steps in transaction agreements may be a reason for governments to defer to self-regulation in obtaining private company environmental objectives as driven by the market.

Depending upon the buyer’s appetite for combined social and for-profit goals, the buyer could further use management equity arrangements to continue certain environmental goals. Remuneration packages, leaver provisions and other incentivisation arrangements could be tied to social objectives in the same manner as economic objectives, mirroring impact fund managers’ arrangements with respect to their returns. If another concern of the hyper scale data centres business is that over the long term, there is a significant regulatory competition risk involved in the organic growth of the business and improved commercial relationships it has over time with fibre optic cable providers and power providers that newcomers may not be able to achieve, management could be financially incentivised to manage the competition risk by diversifying their suppliers, including opting for a choice of alternative suppliers that also meet environmental objectives.

“Green M&A” provisions in transaction agreements that set out joint undertakings of buyers and sellers towards environmental objectives may not sound immediately attractive to prospective buyers where environmental objectives may not seem relevant to a transaction and, in  a private equity context, it may require additional thought around LP remits and fund objectives (especially where timing of the deal is relevant), but the long-term value proposition could outweigh the short term costs since both sides can each achieve the full benefit of the environmental objective and share the cost and, for those longer-term investors, such as private equity in infrastructure, additional timing hurdles that may be required to meet environmental goals could be aligned to the longer investment horizon. In practice, in an increasingly competitive private equity landscape, a “Green M&A” proposition that can be implemented and is positive to valuation could be a differentiating point to propose at the beginning of a bid to be discussed or ignored at the seller’s judgment, but, for the right seller, it could make a stand-out bid for certain targets in achieving the broader environmental, social and governance goals a seller has been looking to achieve and providing positive inputs to the overall investment metrics.

Shareholder engagement with public companies with respect to meeting environmental targets is becoming more common place and institutional investors in private equity funds are being seen to formalise certain commitments in their fund documents to non-return targets. Green M&A provisions in transaction agreements could be a further way for private equity to buyers to cement these objectives from the start of an acquisition. Precisely how to consider appropriate Green M&A provisions for a transaction will depend on the fact pattern and is a point for buyers to discuss with advisors at the early stages of a transaction.

*Leo Rifkind is an Associate at Simpson Thacher & Barlett LLP’s London office. The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.