Exploring The Bottom-Line Impacts Of ESG On Business Valuation

Since Environmental, Social, and Governance (ESG) sustainability frameworks were introduced during the early 2000s, the needs of the 21st-century business environment have become clearer. However, some organizations are falling behind in incorporating these principles into their operations and investment decision-making process. As a result, they are diminishing the value of their organization and overlooking opportunities for maximizing growth. Mark Zyla, a business valuation expert, notes that regulators are sparking change in the industry. By considering the importance of ESG and developing frameworks for measuring its impact on valuation, companies can capture greater benefits. Through Zyla Valuation Advisors, Mark provides analysis for companies allowing them to truly understand the valuation impact ESG practices have on their business.

Before ESG became a mainstream concept in business, many organizations dismissed the profitability this concept could bring. It wasn't until 1998 when the ‘triple bottom line' was introduced that businesses began seeing the benefits of considering people and the planet alongside profit. Once the United Nations released the Sustainable Development Goals (SDG) in 2015, this holistic approach toward business began gaining momentum. 

Although no standardized model for ESG exists, the framework consists of three pillars that encompass a business' non-financial risks and opportunities. In the environmental category, things like energy usage, climate change strategy, and waste reduction become important. Under the social pillar, companies must report and measure workplace safety, diversity initiatives, and human capital management. Governance relates to business transparency, compliance, and ethics. 

Regardless of its vertical, ESG is pivotal for businesses to create value. A McKinsey & Company report highlighted this phenomenon, referencing the results of almost 2,000 ESG studies. According to the results, about 63% of these studies revealed that strong ESG profiles can significantly boost returns. In fact, companies with strong ESG propositions have higher equity returns, a reduction in downside risk, and less likelihood of loan and credit default. 

The report further details that ESG investments can create five types of value: Top-line growth, cost reduction, regulatory/legal interventions, productivity uplift, and investment/asset optimization. According to Mark Zyla, the managing director of Zyla Valuation Advisors, ESG's value creation can translate positively during business valuation. According to Zyla, ESG investments commonly fall under intangible assets like proprietary technology and company branding. While they carry no physical attributes, these assets can optimize a company's value and long-term business outcomes. 

In recent years, the majority of business assets have been dematerialized, which is pushing the business valuation industry to evolve. Regulators like the International Accounting Standards Board and the International Valuation Standards Council are both considering the implications of ESG. Their efforts are influencing the creation of a standardized measurement system that will enable businesses to better capture the value of their ESG strategy. Zyla notes that this transition is very positive for the business climate. "Studies have indicated that ESG can enhance a business's bottom line if they are correctly measured during the valuation process," Zyla says. "In addition to increasing cash flow, ESG can indirectly improve customer retention, recruiting efforts, and potentially lower the cost of capital."

While ESG is gaining traction both in regulatory and business circles, the measurement of this practice is still in its infancy. As the use of ESG in business becomes more universal, Zyla encourages professionals to reference the three biggest drivers of valuation (cash flow, growth, and risk) each time they delve into an emerging concept. 

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