As the world reflects on the health of the planet on World Environment Day, sustainability is no longer a minor concern for businesses. The rise of Environmental, Social, and Governance (“ESG”) factors is shaping the future of value creation and preservation, with sustainability practices as the central driver in modern business valuations.
What is ESG?
ESG is a framework that assesses how a company manages its risks and opportunities related to environmental issues (like climate change or energy usage), social factors (such as labour standards or community impact), and governance practices (including board diversity or transparency). Investors, regulators, and consumers are paying closer attention to how companies perform across these three pillars.
ESG and Valuation: What’s the Link?
Traditionally, company valuations were based on financial metrics such as revenue, profit margins, and market share. However, increasingly, investors are looking beyond the financial statements, trying to determine whether the company is sustainable in the long term.
The following illustrates how ESG impacts company valuations:
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Risk Management
Companies with poor environmental practices, depending on the sector that they are in, may face regulatory fines, reputational damage, or even supply chain disruptions. These risks can lead to lower future earnings and ultimately, a discounted valuation. Conversely, strong ESG practices can reduce risk and lead to a valuation premium.
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Access to Capital
Investors, especially institutional and impact investors, are investing in companies with strong ESG profiles. A higher ESG score can result in better access to funding and more favourable terms, increasing a company’s market attractiveness and enterprise value.
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Operational Efficiency
ESG-conscious companies often operate more efficiently. For example, reducing energy use or waste lowers costs, improving profitability and valuation multiples.
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Brand and Customer Loyalty
Today’s consumers are value-driven. Companies aligned with environmental or social causes often enjoy stronger brand loyalty, translating into recurring revenue and higher valuation forecasts.
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Exit Value and M&A
Buyers are scrutinising ESG compliance in mergers and acquisitions. Businesses with embedded ESG strategies are more attractive acquisition targets and command higher exit multiples.
Valuation in an ESG World
For valuation professionals, integrating ESG means looking beyond traditional financial statements and asking deeper questions:
- Does the business have a net-zero plan or climate resilience strategy?
- How does it treat its workforce and the communities it operates in?
- Are governance structures robust and transparent?
Today, a company's value is defined not just by what it does, but by how it does it.
The Sustainable Premium
As climate concerns escalate and social accountability becomes a baseline expectation, ESG is not just a compliance box – it is a core driver of long-term value. For investors, acquirers, and valuation analysts, understanding ESG is essential to understanding a company’s true worth.