What to Assess in ESG Due Diligence

Environmental (E)

Climate risk: What’s the target’s exposure to physical climate risk (droughts, floods, extreme weather, water scarcity) and transition risk (emissions regulation, technology disruption, market shifts)?

• Assess operations and facilities for physical exposure (location, flood risk, heat vulnerability)
• Map supply chains for climate vulnerability
• Evaluate emissions (Scope 1, 2, 3) and trajectory
• Assess alignment with net zero trajectory and carbon pricing futures
• Evaluate stranding risk for fossil fuel or energy-intensive assets

Environmental compliance and liabilities:

• Environmental violations, regulatory investigations, pending sanctions
• Contamination liabilities (soil, water, air)
• Permit compliance (air, water, waste, hazardous materials)
• Environmental insurance coverage

Natural resource dependency: Is the target dependent on water, minerals, forestry, or other natural resources vulnerable to scarcity or regulation?

• Water scarcity and availability
• Mineral or resource extraction risk
• Agricultural commodity exposure

Social (S)

Labour practices:

• Wage and benefits competitiveness
• Health and safety record (injury rates, fatalities, serious incidents)
• Employee turnover and engagement
• Union relationships and labour disputes
• Modern slavery risk in supply chain (forced labour, child labour)

Diversity and inclusion:

• Gender balance in workforce and leadership
• Pay equity (gender, ethnicity, age)
• Diversity of board and executive team
• Inclusion culture and employee experience for underrepresented groups

Community relationships:

• History of community conflicts or grievances
• Community perception and social licence
• Indigenous community relationships (if applicable)
• Community investment and local impact

Supply chain social risk:

• Supplier labour practices and compliance
• Supply chain safety and wellbeing standards
• Supply chain audits and monitoring effectiveness

Customer and product safety:

• Product safety incidents and recalls
• Customer complaint history
• Regulatory actions on product safety

Governance (G)

Board quality:

• Board independence (percentage of independent directors)
• Board diversity (gender, cultural, skill diversity)
• Board ESG expertise and oversight
• Board meeting frequency and committee structure

Executive management:

• Executive team quality and stability (turnover, succession planning)
• Executive remuneration alignment with performance and risk
• Management integrity and reputation

Risk management:

• Enterprise risk management framework maturity
• Internal audit function effectiveness
• Whistleblower and grievance systems
• Crisis management and business continuity planning

Compliance and ethics:

• History of regulatory breaches or investigations
• Litigation and dispute history
• Code of conduct and ethics policies
• Anti-corruption and anti-bribery compliance

Data and cybersecurity:

• Cybersecurity incidents and breach history
• Data protection and privacy compliance (Privacy Act, GDPR if relevant)
• IT systems maturity and security posture

Disclosure and transparency:

• Quality of financial reporting
• Transparency and communication with stakeholders
• Prior ESG or sustainability reporting (if applicable)

Conducting ESG Due Diligence

Phase 1: Desk Research (Weeks 1-2)

Gather available information:

• Public company disclosures (annual reports, sustainability reports, ASX announcements)
• Regulatory filings and investigations
• Media analysis (news, social media sentiment on ESG issues)
• Peer and industry benchmarking
• ESG ratings and assessments (if available)
• Customer and supplier feedback

Identify risk areas: Based on desk research, identify where target appears weaker on ESG. These are priority areas for deeper diligence.

Phase 2: Target Engagement (Weeks 2-4)

Prepare questionnaire: Develop ESG due diligence questionnaire tailored to target’s industry and identified risk areas. Include financial and operational detail.

Request information: Ask target to complete questionnaire and provide supporting documentation. Key documents:

• Environmental permits, compliance certifications, audit reports
• Health and safety records, incident reports, compliance audits
• HR policies, collective agreements, discrimination/grievance records
• Board and governance documents, committee charters
• Risk registers, internal audit reports
• Insurance policies and claims history
• Supply chain information and supplier audit results
• Prior ESG or sustainability reports

Conduct interviews: Meet with target management (CEO, CFO, HR, Operations, Sustainability/CSR). Ask about material ESG issues, management approach, risks, opportunities. Probe responses.

Phase 3: Detailed Investigation (Weeks 4-8)

Site visits: Visit key facilities. Observe conditions, talk with employees, assess health and safety culture. Facility visit reveals things questionnaires don’t.

Supply chain audits: If supply chain is material, conduct audits of key suppliers. Assess labour practices, environmental compliance, management systems.

Expert consultations: For areas outside your expertise (climate risk, environmental liability, supply chain risk), engage specialists. Climate risk specialist can model physical exposure. Environmental consultant can assess remediation liabilities. Supply chain expert can assess labour risk.

Regulatory checks: Verify compliance status. Check for pending investigations, enforcement actions, compliance issues.

Reference checks: Talk with community members, industry peers, customers, employees. Get outside perspective on target’s ESG performance and reputation.

Phase 4: Risk Assessment and Valuation Impact (Week 8-10)

Assess each ESG risk: For each identified risk, assess:

• Probability and timing of potential impact
• Financial magnitude of potential impact (cost to remediate, operational disruption, revenue loss)
• Manageability (how difficult to fix post-acquisition)
• Integration impact (does this complicate post-acquisition integration)

Rate overall ESG quality: Rate target’s overall ESG maturity on a scale (e.g., 1-5 or simple categories: strong, adequate, weak). Compare to peers.

Adjust valuation: Significant ESG risks should affect valuation. Options:

• Reduce enterprise value: Apply valuation haircut for identified ESG risks. Example: target valued at $100m pre-ESG diligence; significant environmental liability and weak governance reduce valuation by 10-15% to $85-90m.
• Escrow: Structure earnout or escrow to cover potential ESG liabilities. Example: $10m held in escrow for 12 months pending confirmation that environmental liability is addressed.
• Indemnification: Negotiate seller indemnification for ESG liabilities (environmental, labour, regulatory). Seller retains financial responsibility for issues discovered post-transaction.
• Working capital adjustment: Adjust for remediation costs (environmental cleanup, wage adjustments, compliance costs).

Phase 5: Integration Planning (Week 10+)

Develop remediation roadmap: For ESG issues identified, develop plan to address them post-acquisition. Examples:

• Environmental cleanup timeline and cost
• Governance improvements (board changes, policy updates)
• Labour practice improvements and wage adjustments
• Supply chain improvements and supplier transition
• Compliance remediation

Budget integration costs: Allocate budget for ESG-related integration (environmental remediation, governance changes, supply chain improvements, training).

Assign accountability: Clarify who owns ESG remediation post-integration. Usually functional leader (CFO for environmental liabilities, HR for labour practices, etc.).

Common ESG Due Diligence Mistakes

Mistake 1: Insufficient depth on ESG. Ticking boxes on questionnaires without deep investigation misses real risks. Site visits, expert review, and reference checks are essential.

Mistake 2: Over-relying on target’s ESG data. Targets may overstate ESG performance. Verify with independent sources, regulators, experts.

Mistake 3: Underestimating remediation costs and timelines. Environmental cleanup, governance changes, labour practice improvements often cost more and take longer than estimated. Budget conservatively.

Mistake 4: Not adjusting valuation for ESG risk. ESG risks are business risks. They should affect valuation. Don’t overlook valuation impact of identified ESG issues.

Mistake 5: Failing to get board buy-in on ESG assessment. If board isn’t engaged in ESG due diligence, agreed valuations and remediation plans don’t stick. Board needs to understand and agree with ESG findings.

Frequently Asked Questions

How much should ESG due diligence cost?

Small acquisition ($50-100m): $20-50k. Medium acquisition ($100-500m): $50-150k. Large acquisition ($500m+): $150-400k+. Larger deals warrant deeper, more expert-intensive diligence.

How long does ESG due diligence take?

Typically 6-10 weeks for full assessment. Expedited diligence (4-6 weeks) is possible but sacrifices depth. Complex acquisitions with significant environmental or supply chain risk may take 12+ weeks.

Should ESG due diligence be separate from financial and commercial diligence?

ESG should be integrated with financial and commercial diligence, not separate. ESG risks affect financial metrics (costs, revenues, liabilities). Coordinate timing and share findings across diligence workstreams.

How do we know if identified ESG issues are deal-breakers?

Assess materiality. Is this issue material to financial performance or integration? Can it be remediated cost-effectively? Are there remediation regulatory barriers? Serious environmental liability that can’t be remediated might be deal-breaker. Minor governance gaps are addressable post-acquisition.

How does ESG due diligence relate to risk management?

ESG due diligence is part of enterprise risk management. It identifies material risks that affect deal value and post-acquisition success. Comprehensive risk assessment includes ESG assessment. See our ESG risk management guide.

How do we value ESG improvements post-acquisition?

If you improve target’s ESG (supply chain, environmental management, governance), this creates value through reduced risk, operational efficiency, market positioning improvement. Build post-acquisition value into deal thesis. Show how ESG improvement supports value creation plan.

Moving Forward

ESG due diligence is essential to informed acquisition decisions. Invest time in understanding target’s ESG risks, assess materiality, adjust valuation and deal structure accordingly, and plan integration with ESG remediation in mind.

Australian acquirers that do rigorous ESG due diligence make better acquisitions, avoid costly surprises post-transaction, and capture value from ESG improvements.