30 October 2020
In the context of company takeovers, due diligence is usually used to check the condition of the target company, whether there are any unexpected risks and whether a price demanded is considered justified.
There are many pitfalls in such due diligence - glossed over financial reports, infringed patents, current contracts and obligations or relationships with customers, partners and employees.
For example, essential knowledge carriers among employees may not be identified, which may later lead to a high risk of know-how loss, for example due to dissatisfaction after the takeover.
In addition, a special point in risk analysis is becoming increasingly important:
the Technical Due Diligence (also called Digital Due Diligence or IT Due Diligence).
Why is a Technical Due Diligence particularly important?
According to our experience, technology is too often neglected in M&A projects (Mergers & Acquisitions). Instead, topics such as legal, finance, marketing and human resources are strongly in the focus of a due diligence. This is actually an absurdity in today's highly technical world. The reason for this is probably that the initiative for an M&A project often does not come from the technology corner.
Netscape inventor Marc Andreessen, who is also a co-founder of the venture capital company Andreessen Horowitz, already published the unofficial motto of digitization in the Wall Street Journal in 2011: "Software is eating the world". Almost a decade later and in the wake of technological developments, a new motto "Software Is Eating The World, But Services Are Eating Software" now applies. Others again say "Digitization Eats the World". So the technological side is still extremely important - and that's why Technical Due Diligence is becoming more and more important. Ultimately, technology, especially software, is nothing more than an asset that has to be valued in some form or another. And as precisely as possible.
Experts are needed for technical due diligence
Technology, software and software services are diverse, and new developments come onto the market almost daily. This requires a very broad and diversified understanding. Experts for this task have to think, evaluate and act holistically to deliver adequate and realistic assessments. Many years of experience as well as the execution of various due diligence projects create a broad technical backpack, which increases the competence in this important discipline. For example, outdated or little used technologies and architectures must be identified immediately. In addition, one must also be well versed in the other areas of due diligence in order to be recognized as a knowledgeable member of the team. In addition to the state of health of the IT and the "technical debt" (see next section), the question of scalability and future viability is also of great interest - how fit are the technology architecture, the infrastructure, as well as the employees and management for the future? The answer to this question has a concrete influence on the takeover price.
The metaphor of "technical debt" can help
The term "technical debt" is a metaphor for possible consequences as a result of poor technical implementation, deficits and omissions in software development and maintenance that cause a financial burden. The increased complexity increases the effort in every project - so to speak the interest of the technical debt. And of course, this is the language of financial experts - this is the way to reach a consensus with colleagues more quickly.
Once the technical debt has been identified, a lot of conclusions can be drawn that are important for due diligence as well as for the overall risk assessment:
- Identifying risks during a takeover (in the context of M&A)
- Definition and evaluation of measures to be planned in the technical area after the takeover
- Roadmap by means of prioritization for post-acquisition measures (post-merger integration strategy, clean-up activities, decisions on licensing agreements, recognition of reduced development speed due to technical fault, etc.)
- Evaluation of the company in the technical area, and the resulting impact on the overall price of the acquisition
- In the worst case: turning away from the deal
A company takeover stands and falls with both the current and future digital health of the takeover target. If a large technical debt is not or incorrectly identified, this can have devastating consequences after the acquisition. It is therefore essential to have technology/software as an important topic on the agenda of a due diligence from the very beginning.