In-House vs Outsourced ESG Due Diligence in Forest Investment

Why optimizing a combined approach in your timberland, forest or NbS investment deal evaluation maximizes the chance of success, saves you money, reduces risk, builds value and accelerates your decision-making.

Deal due diligence is an exciting time for both the investment manager and the forest business. Most often – by the time you get to this stage, both parties already want to see the deal go through, you may even consider yourself friends with the counterparty.   

But like dating – there’s a lot to get to know about your prospective partner before you make a bigger commitment. From the perspective of the capital provider, which can be a direct investor, or an investment manager allocating capital on behalf of investors – this process calls on several different due diligence skill sets: 

• Technical – This is essentially your operational forest management evaluation. Here you will check the business and operational plans of the proponent against what is feasible. Site and species selection, growth and yield expectations, what is the suitable silviculture regime, net productive area, management capacity, carbon sequestration potential and so on. 

• Market – Here you evaluate the market potential of the opportunity against the proponent’s supposition. You need to look at end markets for the species and associated forest management regime, processing facilities, logistics issues, and regulatory factors affecting product sales. You also need to consider pricing fluctuations in supply and demand. 

• Financial – You need to review cashflow models, transfer and currency risk, tax, leverage, fit with your own return expectations and sensitivities to various risk factors (like changes in price or sales volume, exit timing and so on). 

• Legal – Here you assess legitimacy of your counterparty and their business relationships. You assess the risks, complexity (and costs) of the deal from a legal standpoint. You will evaluate the best way to structure an eventual investment. 

• ESG and Impact – As the acronym dictates, you will evaluate Environmental, Social and Governance issues related to the investment – normally under a risk lens, but if you have an impact strategy – it is here that you will likely also look at the ability of your investment to generate positive ESG benefits.  

The diversity in expertise that is required to evaluate a deal brings with it some obvious questions for the investment manager: 

“How can we be efficient (keep costs low and time short) in thoroughly evaluating a deal, which ideally aligns to our strategy, but might eventually not meet our expectations and result in a broken deal?” 

In this week’s article, I’m going to dig into this from the perspective of ESG and Impact due diligence. We’re going to look at the pro’s and con’s of in-house and outsourcing your due diligence to meet efficiency and investment requirements, while being thorough. 

Pro’s and Con’s of In-house ESG and Impact Due Diligence in Forest Investment 

Before we start, there’s an important caveat that will dictate a firm’s ability to carry out ESG and Impact Due Diligence in-house – and that is the presence of forestry-specific ESG and impact expertise. Focused Timberland Investment Management Organizations (TIMOs) often have at least one sustainability representative charged with this role, where they are experienced in the forest sector. 

Often, however, you find boutique asset management firms covering a variety of asset classes and because of their size, they likely don’t have the need for specialist forest sustainability expertise. 

As an investment manager, wherever you sit in your ESG and Impact capacity – if you are executing an ESG and impact integrated forest investment strategy, a degree of your related due diligence should be carried out in-house. 

This largely relates to screening for strategy alignment and general alignment with your firm’s investment philosophy.  

The pro’s of in-house ESG and Impact Due diligence include: 

• Cost effectiveness – if you already have this expertise readily available in-house, there’s no need to pay someone else to do it.  

• Familiarity with the investment strategy and investment philosophy of your firm – means no lost time in explaining your investment strategy to service providers, 

• Timeliness – if the ESG and impact responsible person has the availability, you are entirely in charge of the timeline. 

The con’s of in-house ESG and Impact Due diligence relate to: 

• Bias from in-house relationships with the proponent or pressure from colleagues to get the deal closed, 

• Lack of expertise in the investment jurisdiction or forestry-specific ESG and Impact expertise can result in missing items or wrongly evaluating risks/opportunities, 

• Timeliness – if the responsible person or team is evaluating a whole pipeline of deals simultaneously, as well as meeting the sustainability requirements of pre-existing mandates – they may not have the time to evaluate a deal. 

The Pro’s and Con’s of Out-sourcing your ESG and Impact Due Diligence in Forest Investment 

Just by reading the arguments for and against in-sourcing your ESG and Impact due diligence in Forest Investment, the inverse can be said for out-sourcing. Here are some of the pro’s and con’s of bringing in external support to help you with your ESG and Impact due diligence.  

The pro’s of out-sourcing ESG and Impact Due diligence include: 

• Timeliness – working with consultants can be a very efficient way to execute ESG and Impact Due Diligence on a tight timeline, when your internal resources are over-extended, 

• Local Context – You can bring in local ESG firms to carry out your due diligence, when you are unfamiliar with the investment jurisdiction. It is likely that these firms will have the benefit of local knowledge and a deeper understanding of the context. If your investment jurisdiction is in the global south – you can have the added benefit that these firms may also be lower cost than bringing in a foreign ESG and Impact expert. 

• Free from bias – With an external party, there is no attachment to the deal going through or not. Your evaluation is more likely to be unbiased and a true account of the ESG and Impact characteristics of the deal. 

The con’s of out-sourcing ESG and Impact due diligence include: 

• Lack of strategic depth – Firms specializing in ESG and Impact due diligence may be so laser focused on the topic of ESG DD, that they fail to recognize the interconnectedness of ESG and Impact to other aspects of the investment – such as technical, market, financial and legal due diligence. You may get a siloed evaluation that doesn’t reflect the true picture of the integrated nature of the business. 

• Cost – As you start to stack up your due diligence needs across different focal areas, your costs can build up – all before you’ve even made the decision to invest. 

• Timeliness – Depending on how advanced your planning and the availability of ESG and Impact service providers, you may be challenged to get your assessment in a timely manner if you have short notice needs. 

The Sweet-spot of Combined In-house and Outsourced ESG and Impact Due Diligence in Forest Investment 

You will observe from the two approaches to Forest Investment ESG and Impact Due Diligence above that (more or less) the same points are raised for both the benefits and drawbacks of either approach – thus it is important to know where you stand and where the con’s might stack up against you. 

In general, I suggest combined in-house and outsourced ESG and impact due diligence. Generally, your due diligence process should be structured so that your DD expenditure only increases as you become more confident in the deal. Ideally, screening can take place in-house. This is where you will assess an opportunity against your key investment criteria for eligibility and identify any red flags. It is here that you will identify any extraordinary ESG or Impact Due diligence, where you might need specialized expertise. Screening should take relatively little time and is likely within the capacity (both in terms of expertise and availability) of your in-house team. I assessing your third party needs, it’s good to be honest with yourself on where you might be too close to the deal or proponent, or where internal pressure exists to invest – where it might add to the credibility of your investment process to bring in third party to avoid a biased assessment. If you decide to integrate external ESG and Impact due diligence support in your deal evaluation – here are some key considerations for choosing the right partner:  

• Ensure your ESG and Impact service provider has a holistic understanding of the forest business your strategy is targeting. For example, if you hire a wildlife biologist or an E&S service provider that doesn’t understand commercial forestry (and this is cornerstone to your strategy), you put yourself at risk of a siloed and unrepresentative evaluation of the integrated risks and opportunities. 

• Ensure your ESG and Impact service provider understands the local operating context. Hiring a foreign service provider that does not either have local experience, or access to local expertise to carry out the evaluation could result in key gaps or inaccuracies in the ESG and Impact findings and may also cost more. 

• Evaluate the strategic capacity of your ESG and Impact service providers. Due diligence in forest investment across the different fields of evaluation is becoming commoditized. As such, so is what is assessed. To avoid a tick-box exercise and to ensure you obtain a locally relevant, strategic assessment – that looks not only to evaluate risks, but to uncover opportunities to maximize financial and ESG benefits, ensure your service provider has both a holistic understanding of the forest business and a strategic mindset. 

Do you need ESG and Impact Due Diligence Support? 

If you are an Asset Manager looking to integrate external ESG and Impact Due Diligence support into your deal evaluation, and you’d like to see if we’re a fit, let’s chat and I’m happy to explain my approach and the types of forest investment strategies I work with.  

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