In this article, the third in our series on M&A, we highlight some of the main elements of a successful technology acquisition process and discuss the pre-deal due diligence and how to manage post-deal integration.
“The rigor and discipline we use in running our business is key to consistently executing our growth strategy. And we systematically applied the same discipline to our investments, including acquisitions.” Pierre Nanterme, chairman and CEO of Accenture.
Before the Deal
Leading up to an M&A deal, valuation is one of the main elements of preparation. But for technology deals where young startups may be involved, Joerg Krings, J. Neely, and Olaf Acker, advisors and practitioners with Strategy&, note that it’s not always so easy to define valuation because there may be no revenue or cash flow on which to base the valuation. Take the Facebook Instagram deal of 2012, for example. In this case, Instagram was a five-year-old startup at the time with no revenue, yet it was acquired by Facebook for $1 billion.
In the case of technology-driven transformation deals where companies acquire as part of a long-term strategy, the price paid might not make sense to investors. Therefore, according to Rob Fisher, Gregg Nahass, and J. Neely, partners with PwC, due diligence is crucial before the deal is made known to investors who may be bemused and less than happy with the high price.
Further adding to the complexity of tech deals is that the due diligence process can be different depending on the type of deal. For example, the scope of due diligence may be limited because the target to be acquired is small, or a billion-dollar company deal may require less due diligence than expected. Big companies may have less to hide than small companies because they have been thoroughly audited or simply because leaders want to keep up the momentum of the innovation work.
James Waletsky, writing for Crosslake, a software consulting firm, lists comprehensive considerations for tech merger due diligence.
- Does the product strategy fit with the investment company’s growth objectives?
- What are the product strengths, weaknesses, opportunities, and threats (SWOT)?
- How does the company determine the product roadmap and what will add the most business value?
Product function and quality:
- Are there any problems with the product that may be expensive to fix?
- Does the product fulfill end user goals or is an expensive UI revamp necessary?
Architecture and code:
- Is there anything in the architecture that is an impediment to meeting growth objectives?
- Are there legacy components in the software that require replacement? What will this cost?
- Are there third-party or open source components that may be problematic from the legal or technical perspective?
- Is the code written in a maintainable way such that others can be productive in the code base quickly?
Processes, practices, and tools:
- Are there opportunities for efficiency gains and/or cost reduction?
- Will the existing practices scale appropriately with company growth?
- Are there existing skills gaps that inhibit efficient delivery?
People and organization:
- Are the right people in the right roles to meet investment objectives (particularly leaders)?
- Who is critical to the business and must be retained with the acquisition?
- Are there significant gaps in the organization that must be filled to meet investment objectives?
- Is the level of R&D spend appropriate for the company size? Are there opportunities for reduction?
- Are there opportunities for cost reduction, such as a move from locally managed resources to the cloud? What is the cost in doing so?
- Is there a suitable business continuity plan in place, and if not, what risk is undertaken and what is required to implement one?
- Are the expenditures reasonable given company size?
- Are deployment practices efficient with minimal risk of human error?
- What are the top support call generators that may be indicative of product problems?
- How many escalations make their way to the development team?
- Are implementation times long, potentially indicating lack of configurability/customization in the product?
- Are there opportunities for product enhancement to scale to a larger number of customers requiring less on the services side?
Source: Waletzky, 2016
According to Waletsky, the risks involved in a tech deal may affect the conditions or price, but the cost of technical due diligence is negligible compared to the potential benefits or costs.
In a white paper, Deloitte has defined a strategic due diligence operation model that can be used in technology deals where a company is targeting companies with dissimilar business models. The model defines some main metrics and identifies which requisite capabilities of the combined company should be retained, changed, or built.
Further Reading: Examples of Due Diligence Process from the Startup World
Some good news for firms needing help with due diligence: venture capitalists have been doing this for a long time. The following are documented examples of due diligence from investors in early stage startups.
After the Deal
Finalizing a deal is half the battle. After the deal, the hard work of integration begins.
Successful integration may rely on the newly acquired management because the technology that is of value is most likely held by a small group of creative leaders. Experienced managers are needed to oversee smooth operations, particularly when a company is buying large operating units.
Relying on acquired management, however, can be a problem. Some of the senior team from an acquired company may decide to leave after the deal closes and look for other opportunities. Given this potential reality, the acquiring company needs to consider how much it will rely on these senior managers and for how long. According to Fisher, Nahass, and Neely, retaining people contractually is often just a short-term solution.
According to Adam Bluestein, writing for Inc., it’s important to hold on to the people who are integral in a smooth transition, such as technology managers and those with crucial knowledge of the acquired technology. The acquirer needs to keep the managers’ hearts in the game by understanding the environment people are already thriving in and reassuring them that the crucial stuff won’t change – or if it will, providing them with the tools and resources to cope. A change management strategy is vital and should be prepared early in the merger decision process to ensure that the associated costs are considered.
Integration Leadership – Don’t Let Cultural Problems Get in the Way
“When you merge cultures well, value is created. When you don’t, value is destroyed…. The game is won or lost on the field of cultural integration. Get that wrong and nothing else matters.” George Bradt, chairman, PrimeGenesis
Cultural integration should be part of a change management strategy for mergers. AON found that cultural issues that occur when two entities are merged are a main driver of deal failure.
Image source: AON, 2011
A study by Bain & Company that polled executives who had managed a merger also found that the number one reason given for deal failure was “culture clash.” Team synergies are important and, according to George Bradt, chairman of PrimeGenesis, “Synergies must be created together by teams looking beyond themselves to new problems they can solve for others.”
In the graphic below, Deloitte gives excellent insights into M&A from the perspective of those on the ground. The graphic shows how morale is affected from the time before the deal is signed through the post-merger period.
Image source: Deloitte, 2007
The culture of an organization is largely set by its leadership. But what if that leadership is in transition?
Dale Stafford and Laura Miles, partners with Bain & Company, recommend cultural integration tools that can gauge the mindset and behaviors of employees and encourage better working processes. Managers and leaders can gain a better perspective of how integration is processing or where changes need to be made.
For example, according to Stafford and Miles, videos of employees working and process flow maps can show the different ways a task is undertaken and can guide a discussion of how it should be done in the future. Customer interviews can provide insights for employees into customer perceptions of each organization. And employee surveys can both collect important data and be used to show employees that their opinion matters – but only if the results stimulate action from leaders.
The fourth article in this series, “M&A – Divestiture for Value Creation,” addresses the often-overlooked subject of asset divestment. In addition to acquiring skills and technology through mergers, firms can increase their value by selling assets that detract from their core business functions.
West Stringfellow spent over 20 years launching products and leading innovation at corporate giants and startups, holding management roles at Target, PayPal, VISA, Rosetta Stone, GraysOnline and Amazon.
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