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Understanding the Importance of ESG in Business Valuation

As the Environmental, Social, and corporate Governance (ESG) topic gains growing attention in the regulatory and investment environment, its impact on business valuation has become increasingly relevant. Despite the numerous recommendations for companies to account for and report on their ESG aspects, there is still uncertainty about how to quantify its value in the context of a company valuation. We reviewed the existing approaches to the ESG aspect in business valuation and explored its contribution to a company's value and economic performance.

Retrospective consideration of the ESG aspect proves that it evolved from Corporate Social Responsibility (CSR) and is essentially a set of activities aimed at obtaining a "social license" for a company. Research has shown a positive correlation between a company's ESG index and its business performance¹. Companies that incorporate ESG considerations in their operations are likely to see benefits such as cost reduction, reduced legal expenses, better labor productivity, growth stimulus, and improved access to capital and potentially increased investment returns.

Existing public discussions and research on accounting for ESG performance in business valuation operate with these two main approaches:

-        Does ESG impact a company's value at all?

-        How to price a company’s ESG performance and incorporate it into existing valuation methodologies?

According to the International Valuation Standards Council’s (IVSC) ESG and Business Valuation guiding document, incorporating ESG into business valuation methodologies can be done through the income approach or the market approach². The income approach suggests amendments to the Discounted Cash Flow valuation method by considering the impact of ESG on either the discount rate or the cash flows. The market approach, on the other hand, suggests amendments to the Market Multiple Valuation method.

The importance of considering ESG in business valuation is evident. Companies that integrate ESG considerations in their operations are likely to see a range of benefits that contribute to their overall value and economic performance. While the specific approaches to incorporating ESG into business valuation methodologies may vary, the underlying principle remains the same - ESG performance shall be considered in any comprehensive business valuation.

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