A lot has changed in the business landscape in recent years. A significant part of this involves Environmental, Social responsibility and Governance (ESG) measures that enable companies to operate more sustainably and responsibly. Whether entrepreneurs support or oppose incorporating ESG into their businesses, laws and regulations are changing rapidly and entrepreneurs will have to respond sooner or later.
Back in 2014, the Non-Financial Reporting Directive introduced rules for companies with more than 500 employees of public interest. In 2021, the Corporate Sustainability Reporting Directive was adopted and come into effect this year. Although these rules apply to large companies, this trend of tightened regulations will eventually affect SMEs as well. About 99% of all companies in the European Union are SMEs. So these companies are crucial to the European economy and can contribute immensely to making Europe more sustainable.
When encouraging action, two primary approaches are often refered to as “the carrot and the stick.” The stick mainly punishes to spur people on. Often laws and regulations are seen as the stick. On the other hand, we have the carrot, which actually rewards people when they do something. Often only the stick is seen, while the carrot can offer great benefits. In the context of ESG, there are two distinguished rewards: green loans and increased company valuations.
First, there are green loans. These are loans with lower interest rates provided to encourage companies to invest in sustainability. Sustainable companies can qualify for such green loans if they meet certain requirements. Examples of requirements are that the company meets certain safety requirements or contributes to one of the EU’s Sustainable Development Goals. In return, the company can borrow at a lower interest rate, lowering its cost burden. A concrete example of a green loan offered in the Netherlands is the BMKB-Groen scheme. This loan allows SME entrepreneurs to reduce their energy costs, for example, by investing in making their business premises more sustainable on favorable terms.
The second benefit of sustainability is an increased business value. Entrepreneurs planning to sell their business place great importance on achieving a higher enterprise value. This enterprise value is determined by the company’s future cash flows and risk rate. Several studies have shown that sustainable companies achieve higher price in M&A transactions compared to less sustainable businesses. This is due to several reasons. Large companies are already working to make their supply chains more sustainable, which reduces risks and increases the certainty of future cash flows. Moreover, research shows that companies that invest heavily in ESG are more resilient in tough market conditions. For example, companies that were highly engaged with their employees and stakeholders were more likely to stay afloat during the tough coronagraph. Such resilience in tough conditions means the company carries less risk, which also increases the company value. Finally, part of the enterprise value is determined by the adjustments that will be made after the merger or acquisition; the so-called integration costs. The more sustainable the company, the easier it is for the buyer to integrate the company, resulting in lower integration costs are lower and higher enterprise value
In short, ESG not only brings laws and regulations, but can also mean great benefits and opportunities. The sooner companies look into this and invest in it, the bigger the difference they can build on now. Sooner or later, companies will have to start investing in ESG due to laws and regulations, and companies that start early will be better prepared for this in the future.