Modern business is deeply integrated with technology
Businesses across all industries are using information technology, and the companies with the largest market capitalizations are in tech. These trends are only accelerating in light of the pandemic as hybrid and remote working force the embedding of technology within processes and strategies, which in turn has propelled the market for tech products and digital services.
The meteoric rise of modern digital business has transformed M&A
As companies become wedded to tech and software as key productivity drivers, M&A activity has advanced in kind. The global number and size of deals was stable in 2019 and down in 2020 due to the pandemic, yet activity in the tech sector is thriving. Putting technology at the core of a business is key to building a responsive organization that can thrive in uncertainty.
In Datasite’s Deal Drivers: EMEA Q1-Q3 2020 report, tech companies led EMEA M&A activity in terms of both deal value and volume, and in all but two regions, tech companies were most likely to be put up for sale. What’s more, large tech companies have by far performed best during the pandemic as the rest of the economy has gone into reverse.
This is a tremendous opportunity for companies:
- M&A targets want to emulate the success of modern digital businesses to gain greater liquidity, and with it, growth potential – excellent news for investors.
- Investors want high-growth, high-cap tech companies in their portfolios – a huge opportunity for smart, tech-focused businesses.
All this positive activity is not without its drawbacks, however, as technology and IT are becoming a significant source of risk in M&A deals. In an analysis of over 1,500 due diligence contracts performed by BearingPoint Capital and West Monroe Partners:
- 85% of businesses experienced medium to severe risk-related issues that required remediation within the first 90 days of ownership.
- A lack of tech due diligence was seen to have a negative impact on deal valuations.
- More than half of the time, significant future unbudgeted IT funding requirements at both the CapEx and OpEx levels were seen to have a material change on deal models.
- 50% of the time IT was seen to lack strategic direction and not align with the overall business.
- More than half of projects involved businesses with poor or missing disaster recovery capabilities.
- Around a third of lower middle market companies showed key person risks and IT team skill deficits.
To manage these significant IT and technology risks and safeguard future M&A activity from devaluations – or the complete failure of the deals themselves – businesses must reduce, and investors must understand, tech risk.
M&A technology workstreams reduce risk to preserve value
No M&A activity should take place without establishing specific workstreams for different aspects of tech-related due diligence. This way, you can identify sources of risk, then remedy issues or purchase with confidence.
Strategy
Does a company have tech and IT strategies and roadmaps that are aligned with wider company strategies and designed to support business growth? If IT initiatives are planned for the next 1-5 years, what are they, why are they taking place and what is their perceived benefit?
People
Tech companies are reliant on talent, but a balance must be struck if staff are not to have an impact on M&A. Skills gaps must be identified and eliminated so teams are as capable as possible. And if specific knowledge of software development and architecture is only understood by a few key people, their insights must be made more transparent. This might involve the business doing more to earn staff loyalty, gain application knowledge, and use this to secure the M&A transaction.
Technology platform and architecture
If a company is built around software applications – production or usage – these must be optimized. Technical debt must be estimated, and solutions devised; spending should be analyzed, and its evolution projected; architecture must be seen to support commercial growth through scalability, extensibility, and integration potential; and applications must be analyzed in terms of their health and potential to support ongoing business growth.
Cyber security
A poor approach to security will impact M&A valuations. To reduce security risks, a company must conduct yearly penetration tests, develop and test disaster recovery and mitigation plans, and thoroughly identify and learn from any security breaches.
IP ownership
If an organization deals in technology services or production, control of intellectual property is paramount. For example, if software is built on source code featuring open-source components, but the license requirements of those components have not been adhered to, then there is a risk the entire piece of software – and the business’ value – could become open-source.
Compliance
Does a business understand and adhere to GDPR, US sector and medium-specific law, or the many other robust pieces of legislation used across the globe?
Tech and M&A activity is now closely interconnected. The prospects are immense – companies will benefit from a pivot towards tech and enjoy growth accordingly, but it is crucial you act smart. With an encompassing approach to tech due diligence, risks can be mitigated to prepare for M&A transactions and guard against post-sale risks.
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