Why IT Due Diligence Matters In Mergers & Acquisitions
Value creation is the ultimate goal for any merger and acquisition deal, and M&A deals are a common strategy businesses take to create value while increasing their growth and shareholder returns. However, since the pandemic, many financially liquid companies have sought M&A deals for a more critical need: digital transformation. But why?
The Future of Business: Reliance on Technology
The pandemic has given us a glance into the future: our increasing reliance on technology, whether it’s videoconferencing software, IoT, AI, or cloud-based tools. It is no surprise that since the second half of 2020, we witnessed a boom in tech-driven M&A deals, with an overall global increase of 91.8%, according to GlobalData. Businesses realize that technology helps them scale operations to a new level. Non-tech businesses are acquiring tech companies to speed up their digital transformation process, while hardware-focused companies are developing software companies because of the SaaS model’s attractive revenue streams. Look at how Broadcom, a renowned chip-making hardware company, acquired VMWare, a virtualization and enterprise cloud vendor, to expand their businesses beyond just making hardware, as those days are long gone in an increasingly cloud-driven world.
Technology can’t be ignored during M&A
Even though value creation is the end goal of every M&A, it’s also a challenging endeavor. Many deals end up fizzling out in disappointing numbers and synergies. According to PwC and Mergermarket’s study on M&As, more than 70% of mergers fail to deliver their anticipated value. As technology increasingly permeates all business aspects, understanding a company’s IT assets, systems, and processes becomes crucial during an M&A deal. Failure to do so results in negative synergies from potential tech debt, inadequate post-M&A integration, and a lack of clarity in future value creation strategies, especially regarding the broader portfolio review. Investing in IT due diligence or ITDD, an audit of a company’s IT infrastructure, architecture, and processes, allows you to make more informed, value-based decisions that directly impact how you create a more valuable offering to your consumers.
In a technology-driven world, neglecting ITDD before an M&A is almost unthinkable. However, failure to conduct ITDD impedes the objective assessment of your target’s value. Through ITDD, your company better determines whether your target prospect has the IT infrastructure, assets, resources, and processes to support your business in achieving your objectives. Understanding the former crucial information aligns the M&A deal with your current and future business strategies rather than striking the deal as mere cash grab opportunism. In addition, ITDD helps you answer critical questions about your target prospect. How will the target company create added value in your existing portfolio? Are there any potential IT opportunities, business efficiencies, and synergies between you and your target company’s systems and business offerings? Suppose your ITDD analysis of your target company reveals that the M&A substantially impacts your business operations; you may leverage the information during negotiations with your target company to determine the purchase price; to raise the purchase price according to the value or the opposite. Ultimately, ITDD results will inform your business’ financial models, risk mitigation strategies, or possibly an exit strategy post-M&A if the deal goes south.
Integration is key
The heart of an M&A is integration. Integrating different parties with different corporate cultures, people, IT systems, and operations is essential post-M&A. Behind every great tech lies great people, and onboarding their people regarding any changes following each acquisition is crucial. Conducting an ITDD helps you integrate better with your target company’s operational processes and systems. Not completing an ITDD leaves unsettled issues; what if you and your target companies have different general policies or employ other IT systems to manage workflow, human resources systems, and performance, and these changes are not communicated to relevant stakeholders? An ITDD eases your process of navigating any differences in workflow between different parties since other organizations use different IT systems to manage their inputs and outputs. As you communicate and onboard your employees with proper action plans post-M&A, ITDD analysis, and its findings equip you with validated information.
Know your tech debt
Following more significant regulations and reliance on technology, IT risks, tech debt, and cybersecurity are critical areas of technical due diligence. According to Financier Worldwide, 10% of M&A deals were abandoned due to software risks, and the number continues to grow until today. December 2021 was the highest month for the number of abandoned M&A deals. Technical debt are usually present in a company’s codebase, comprising decisions made about IT architecture, design, and deployment practices that financially cost the firm in the long run. Think of risky swept-under-the-rug software architecture or code issues. According to a McKinsey report, technology debt accounts for 20% to 40% of the respondents’ technology estates. It’s normal for most large companies to “owe” in unpaid tech debt. The focus for M&As here, is to be aware of your target’s tech debt, and how it’s being be managed. With a thorough ITDD, you’ll be able to get a clearer picture of what to expect from your target’s IT systems, security protocols, and software architecture upon integration. If your target has unaddressed tech debt, it will hamper the stability of your existing IT architecture and systems, disrupt core business processes, and cause time management inefficiencies as your developers spend 13.5 hours weekly to solve tech debt, on average. Clearly, the costs of being unaware of your target’s tech debt and how it’ll impact you, are too great to ignore.
In 2016, Verizon acquired Yahoo! in a deal worth 4.8 billion dollars. After completing the acquisition deal, Verizon discovered two large data breaches at Yahoo!. Verizon was granted a 350 million dollar discount for the deal, while Yahoo had to pay 80 million dollars to settle lawsuits from its shareholders. Clearly, poor to no IT due diligence on your target’s cybersecurity and potential security vulnerabilities is costly. Beyond just data breaches, what if your target firm’s IT workflows are dependent on third parties access, and what are its risks? Through an ITDD, you can identify your target firm’s security vulnerabilities, their current cyber processes, and assets. Through this information, you can develop improved security protocols, and discover and solve potential security gaps post-integration. Being aware of your target’s security vulnerabilities gives you a competitive advantage. For example, you can leverage this knowledge by negotiating with your target to give a discounted purchase price. At the same time, you agree to pay for potential investments in data protection and security post-integration, for instance.
Before jumping into analysis or further evaluation, gathering as much information as possible about your target makes a difference in your assessment. Tokyo Techies typically prepares an ITDD assessment checklist when gathering information about our clients. We assign priority numbers to assess our client’s system design, source code, IT servers, and more and determine which requires critical evaluation. From cyber audit reports and operation manuals to system structures, we make sure that we cover all bases, with a priority number from 1 to 99! Click here to read our IT M&A due diligence process.
In our latest ITDD case, Tokyo Techies was in charge of supporting Oyo Japan and KC Technologies for an acquisition deal, as Oyo Japan intends to sell Oyo Life to KC Technologies to focus more on their hotel offerings. From our side at Tokyo Techies, we supported both parties by evaluating the current infrastructure of the property management platform, addressing all technical challenges, and developing a concrete plan for system migration and maintenance post-acquisition. Before proceeding with our analysis, we first begin by clarifying expected deliverables and understanding the ITDD’s scope of work and objectives, as seen in our Due Diligence process for IT M&A.
After thorough analysis and evaluation, we could move forward to the final stage of Reporting by identifying the significant challenges Oyo Japan faces as it migrates Oyo Life to KC Technologies. Learn how Tokyo Techies migrated a property management system in three months with no issues post integration.
ITDD for tech M&As helps you identify your target’s IT and software risks and how they’ll impact you. You can better define and evaluate your IT strategic planning after the takeover and have a roadmap of your post-merger integration strategies or any post-M&A measures. Most of all, you’ll achieve a more accurate valuation of your target that includes IT capabilities, assets, tech debt, and security vulnerabilities that can potentially bring you a competitive advantage upon negotiations.