ESG in M&A: how to do things right for your employees

Environmental, Social and Governance (ESG) concerns are becoming more central to the way businesses operate, including with respect to how employees are treated. One area where this can be seen is in transactions involving Mergers and Acquisitions (M&A), which will affect not only existing employees but incoming employees as well.

This blog sets out the ESG considerations organisations should bear in mind in the context of a M&A transaction.

What do employees have to do with an M&A transaction?

Employees are just one of a company’s many assets that will be impacted by an M&A deal. For example, the parties to the deal will need to consider whether the employment policies and practices of the other party to the transaction (ie the company being ‘merged’ or the ‘target company’ being ‘acquired’) will complement their own business. The employees themselves will also want to know what lies in store for them.

What do employment issues have to do with ESG?

As noted in our blog from last year, the ‘Social’ and ‘Governance’ elements of ESG tend to be the most relevant from an employment perspective. Social factors encompass how a business manages its relationships with its employees and workers, while governance factors include how a business approaches its leadership, decision-making and internal practices. Clearly, such concerns already lie at the core of employment considerations, so it makes sense to create moments within any M&A transaction timeline to consider these issues.

What ESG employment issues should be considered during an M&A timeline?

ESG issues can be considered using four broad categories: (1) policies, (2) people, (3) pay, and (4) potential vulnerabilities. These aspects should be considered at both the pre-transaction and the post-transaction stages of any M&A deal.

Pre-transaction ESG due diligence

The goal of ESG due diligence pre-transaction is to gain insights into the nature of the target company and its potential risks and opportunities. This means identifying its existing ESG standards across the four key areas:

1. Policies: Information regarding each company’s employment policies and procedures should be exchanged and reviewed, to help the parties determine whether their ESG-related values align. This could include health and wellbeing policies, disciplinary rules, workplace inclusion strategies and anti-corruption and fraud policies. A joint ESG vision could be incorporated within transaction documentation. This might include provisions promoting the fair treatment of employees, for example, softening the impact of the M&A on employees.
2. People: The parties should strive to exchange workforce data (including board composition data), including around equality and diversity, retention, wellbeing, absence and performance. This would allow parties to identify and analyse any existing problem areas, such as workplace inequalities or potentially discriminatory practices. Where appropriate, the parties could consider adding terms into the M&A agreement to help with tackling the issues before the transaction is concluded.
3. Pay: Data relating to gender pay and executive pay should also be exchanged for the same reasons as above. It is a legal requirement for organisations with over 250 eligible employees to publish their gender pay gap and for UK listed companies with over 250 employees to disclose their CEO pay ratios (calculated by dividing the CEO’s compensation by the pay of the median employee). In respect of gender pay, the buyer or merging company will want to ensure compliance with these obligations, along with appropriate actions where there is a pay gap. Regarding executive remuneration, this should ideally be used as a tool for raising standards within the business by, for example, tying bonuses to environmental or social goals.
4. Potential vulnerabilities: It is important to identify any claims or complaints that the target or merging company might have been subject to in order to identify any ESG incidents or allegations. This could include whistleblowing claims relating to toxic cultures, environmental issues, or accusations of greenwashing. Due diligence should also extend to the target company’s supply chain. Is there a risk of human rights or environmental violations anywhere within that? Assessing this could depend on how engaged the target company is with its suppliers already.

Post-transaction actions that can boost ESG

Following a transaction, the goal will be to implement an action plan that would address any ESG risks or deficiencies identified as part of pre-transaction due diligence and put a process in place to ensure integration of approach. This could work both ways: action could be taken to improve the policies and practices of the target company to bring it up to the standards expected by the acquiring company. Equally, the acquiring company could adopt best practices at the target company if they have a strong approach to ESG.

It is important to note that if the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) apply, then variations to transferring employees’ contracts will be void if the sole or principal reason for the change is the transfer (other than in certain circumstances). Subject to that, here is a reminder of ways to boost ESG in organisations post-transfer:

1. Policies: Both the target and acquiring company should ensure they have an ESG strategy and policies of comparable scope and standard (see here for suggestions of what this might cover), with appropriate training and enforcement to ensure they are effective. Additionally, employment contracts and handbooks could be made greener for future hires, for example by incorporating electronic signatures to avoid printing, as well ensuring clauses are climate friendly (see our blog on making contracts more sustainable).
2. People: What initiatives could be implemented to incentivise staff to stick around and to attract new talent? Engagement initiatives, culture audits and 360-surveys could go a long way in creating an environment of openness. Corporate Responsibility (CR) and Equality, Diversity and Inclusion (EDI) schemes may help, too, such as paid volunteer days and social mobility programmes. Moreover, enhanced family-friendly employment practices could be implemented, and might include more generous provisions to reflect recent changes in the law, such as on flexible working, and protection from redundancy during or after maternity leave or shared parental leave.
3. Pay: Employers could use pay to promote sustainability. This could include rewarding eco-friendly commuting with cycle-to-work and e-vehicle schemes. Pay and bonuses for senior executives could be tied to environmental and social targets, while pensions for all staff enrolled in the company pension scheme could be invested, as a matter of routine, into ethical and green funds. Additionally, organisations could consider their approach to pay transparency, ie by openly disclosing compensation of current and prospective employees, which could work to combat gender pay gaps in the workplace.
4. Potential vulnerabilities: How can companies ensure that ESG standards do not falter? The answer boils down to one word: values. Embedding ESG elements into a company’s values can drive a company’s strategy and organisational decision making. This, in turn, will communicate the organisation’s level of ESG ambition to its employees and other stakeholders, as well as to the wider market. Practically speaking, the company’s operational targets, progress updates and KPIs can be aligned with ESG elements to ensure buy-in from the entire organisation. Furthermore, the company’s suppliers and subcontractors could be required to be open and transparent in sharing data about their ESG credentials. In that way, the company can set high ESG standards for its own suppliers, as well as for itself.

Conclusion

ESG considerations should be at the forefront of decision making of any M&A transaction. In doing so, a business can ensure it remains a responsible employer to its existing and incoming employees alike. Moreover, this approach can greatly benefit the business itself: by setting it up, from the outset, to operate sustainably in the ESG-focused world around it.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, September 2023