Risk assessment is a major play for M&A due diligence

Jeffrey McBrideJeffrey McBride

Practice Director
Environmental

Daniel SmithDaniel Smith

Practice Director
Remediation Program Management

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May 12, 2022 - Despite rising interest rates, merger and acquisition (M&A) transactions are showing signs of continued and robust recurrence in Q2 of 2022. S&P Global Market Intelligence reports that the financial sector, real estate, healthcare, and information technology were all major players in the M&A dealings of 2021, reaching a staggering $2.459 trillion. Numbers over two trillion dollars have only been seen once since 2015. And while this year may not experience expenditures quite at this level, they are expected to be substantial. BSI’s experts weigh in on this trend and offer insights as to why environmental due diligence and risk mitigation is a critical aspect of these transactions.

It is likely we will see an enormous uptick in M&A dealings over the next few years, offers Dan Smith, Practice Director, Remediation Program Management. Now is the time to make sure risk models are ready to go before this wave hits. Given the events of the last several years and increased focus on sustainability initiatives, supply chain constraints and security, fair labor practices, and product stewardship, the risk models and strategies developed as recently as 2020 that focused primarily on adverse impacts to property or operational compliance alone may no longer be sufficient for future transaction evaluations. Strategically addressing risk can now create a profit-building revenue stream in what was previously a financial drain.

Commercial space acquisitions are certainly going to continue, especially as many organizations adhere to a hybrid working model and no longer need to carry the cost of large buildings, says Jeffrey McBride, Practice Director, Environmental. Additionally, as construction costs are surging and housing prices are near record highs, the opportunity to refurbish or retrofit a company’s existing property potentially from an industrial use to a commercial or residential space is becoming more prevalent. Coupling this risk strategy with tax and other incentives to redevelop historically contaminated or brownfields areas into greenspaces, commercial, or residential zones, risk management can lead to significant profits in redevelopments.

What’s more, as global economic unrest and significant supply chain constraints continue, some businesses are suffering. Profitability rates are dropping beyond the point of survival and owners could be looking to cash out while they still have equity left in their organization. This is the perfect opportunity for those looking to buy in a repressed market.

In any scenario, McBride continues, it is essential to evaluate the risks of a potential investment from all angles before making the deal. An area often overlooked or not fully understood in the M&A process is supply chain stability. The various risks associated with supply chain can be detrimental to a businesses' success and are often happening unbeknownst to an organization’s leadership. Issues like criminal activity leading to theft or loss of goods, labor disruptions, environmental risks, and forced child labor practices should be thoroughly investigated.

It is extremely important to identify risks upfront in the context of the proposed transaction, Smith agrees. If not evaluated ahead of time, supply chain instability issues along with environmental impacts, community acceptance, permit transference or termination, and surprises related to operational health and safety liabilities can all become very expensive to manage down the road. Depending upon the parameters of the transaction and how liabilities may or may not transfer with the assets, business costs associated with these risks often far outweigh the cost of initial due diligence, yet we often see many businesses limit their due diligence to simple Phase I Environmental Site Assessments (ESAs). Effective due diligence goes way beyond the Phase I ESA in most M&A scenarios to protect the interests of the parties involved in the transaction. The importance of considerations not covered by the Phase I ESA process is becoming even more critical with the recent changes in how Sustainability initiatives must be documented and reported and the shifting focus of most global brands. Establishing and laying out the business goals from the inception of the process will significantly improve the effectiveness and value of achieving the due diligence objectives.

For example, McBride explains that from an environmental compliance perspective, including risk factors for current and future operating conditions of the target is imperative to ensure they are both adhering to all regulations and permitted with capacity to allow for expansion of production. The last thing a company wants is to do is acquire another business or property that has a tarnished compliance history or is handcuffed with permits that do not allow for expansion after acquisition. In the court of public opinion, improper due diligence could put a black eye on the acquiring organization, and the lack of operational flexibility due to permit limits could reduce profit margins on the investment.

Wading through historical data in the due diligence process risk requires a large commitment upfront from any buyer. There are a ton of documents and data to analyze, McBride says. What a buyer needs is a partner that understands the buyer’s objectives, then manages, organizes, and interprets the data to best meet the buyer’s objectives and fully realize and articulate the risks associated with the investment.

Also, if any sort or redevelopment work is going to be done to an acquired building or piece of land, Smith adds, it is important to understand if contamination may be present in areas to be disturbed to support redevelopment. In many instances these areas may not have been previously investigated because they were underlying existing infrastructure and inaccessible in the past, but they become exposed when demolition or new construction begins. You never want to walk into a brand-new transaction and have two million dollars’ worth of surprise clean-up to do, he warns. For example, changes in use from commercial or industrial applications to residential development can trigger more stringent environmental cleanup standards, adds McBride, as well as compliance targets. Part of due diligence is knowing if there is any sort of contamination and how to remediate it correctly and efficiently with full understanding of the future use of the property.

By combining research in the areas of environmental risk and supply chain intelligence, companies are better poised to mitigate merger and acquisition risk and structure deals that can turn potential costs into increased profits. Watch the complete expert interview and follow along with our Thought Leadership and Experts Corner content for other EHS topics.