Acquisitions: IT has become an essential element in M&A deals. And the onus is increasingly on the company up for sale to prove that its IT will be an asset for the buyer.
Recent changes in UK legislation demand that anyone wishing to sell a house must provide a homeowner's report on its provenance and state of repair. While not a legal requirement for the sale of a company, a similar report on its financial and operational state is fast becoming a prerequisite.
A vendor due diligence (VDD) report is an increasingly important element in attracting potential buyers. Not only does it cut the cost of the buyer's due diligence exercise, but it also provides a clear picture of what is on sale. Both factors will inevitably affect any potential deal.
IT systems and processes are central to most businesses and are therefore a key component in any VDD report. The state of IT could easily tip the balance in a deal. If the report shows, for example, that the company up for sale is in the throes of a major IT system roll-out, it might be a reason for backing out of the deal. A long-term obligation to an outsourcing contract could also put a potential buyer off.
The IT element of a VDD process is usually carried out alongside the traditional due diligence examination of financial, operational and market factors. But it is essential that IT systems are looked at in the context of the sale because there are no hard and fast rules.
The impact of IT in a deal varies enormously. If, for example, the sale is likely to attract commercial trade buyers, issues such as integration with the buyer's IT systems will be high on the agenda because although this involves additional one-off costs, there should also be considerable operational and back-office savings following the integration.
But if the buyer is more interested in grooming the company for future sale, integration is less likely to be important. In this case, working, self-contained IT operations could be more attractive.
Where there is to be a "carve out" from a business, which involves separating the IT from the remaining business, there are issues involved with separating the infrastructure, applications, data and support.
Well-developed IT separation plans go a long way to alleviating the concerns of potential buyers, and should provide the buyer with a view of both the separation costs and the potential ongoing costs post-separation.
Costs post-separation can include estimates of a standalone IT infrastructure, hardware, applications and supporting IT function; outsourced services; ASPs; or a combination of all these.
While the impact of IT will depend on specific circumstances, the VDD process provides an opportunity to define the current technology infrastructure and its role in supporting the business. This gives prospective buyers a picture of where IT sits in the context of any future deal.
The first phase of IT VDD is to catalogue the current IT inventory. It is essential to look at the complete package of hardware, software and services. Factors such as the age of the hardware and the software platforms, the extent of outsourced services and available human support skills are key elements.
If the hardware needs replacing or software support for key systems is no longer available, this will add to the post-deal costs. Similarly, ongoing outsourcing contracts could increase long-term financial liability.
Starting with hardware, the VDD report must provide an assessment of current equipment and its projected lifespan. If it is nearing the end of its life, the buyer will have to spend money on technology renewal. Even if the hardware technology is up to date, the VDD assessment must take account of the business plans. If the company is growing so fast that it will exceed the current capacity quickly, buyers need to understand the scalability options and associated costs.
The resilience and reliability of current systems, together with business continuity plans, must also be examined closely. At Deloitte we have come across examples of companies where the business units' understanding of acceptable downtime was significantly out of step with the IT department's view.
The same criteria apply to software. Companies that have lagged behind the technology cycle and hung on to obsolete software past its support date will face increasing difficulties, a factor that will, again, raise questions in a buyer's mind.
The VDD report should also show the impact of outsourced services on IT provision. These can range from simple hardware maintenance and software support arrangements to complex facilities management contracts. Many will be straightforward standard contracts. But some may involve long-term contracts with small, unreliable suppliers.
Although not central to the IT section of a VDD report, it is important to examine human resources - both from the skills point of view and current staff morale. It is essential to identify the key skills available to support the IT systems and understand their future role. If staff morale is low, it is likely key skills will be lost after the deal is completed. Buyers must therefore be able to see what impact this might have.
The IT team's criticality is exacerbated by in-house bespoke developments that limit the provision of sourcing external support. Comprehensive documentation is imperative, although a rarity, and is the key step that many projects fail to conclude. A lack of adequate documentation creates undue reliance on the IT team and this can worry potential buyers.
Another potential area for concern is an ongoing large scale IT project. There are no hard and fast rules - but generally, unfinished IT systems ring alarm bells in the minds of potential buyers.
There are exceptions. We recently worked with a large global business in the process of rolling out a new bespoke IT system. The system was designed and built internally - usually a cause for concern. But the company had a pilot project running and had done its job well. After examination, the successful pilot project showed that the new system, far from being a liability, would be an important asset.
It might sound like a clich‚, but most VDD is common sense. It seems quite obvious to check that the IT systems are up to date and support the business properly. Clearly, any ongoing contract liabilities must be flagged. And the effect of the sale on key staff is an important factor.
The impact of these factors will vary, but the important thing in vendor due diligence is to produce an objective and independent assessment of a company putting itself up for sale. The central role that IT plays in most businesses today means it is bound to be high on the agenda.
The equivalent of a homeowner's report, it therefore clearly identifies the costs and liabilities associated with IT support and what impact they may have on a successful deal.
The key questions to answer
Is the technology current?
- How well does the technology support the business?
- Is the functionality fit for purpose?
- Is the technology robust, stable and resilient?
- Are effective business continuity plans in place?
- What are the significant risks and how can they be mitigated?
- What are the short/medium-term capital requirements?
- Are the operational costs sustainable and where can savings be made?
- What effect will this transaction have on the technology, ie separation?
- Who are the suppliers and what long-term commitments will the buyer have to meet?
Chris Digby is a partner in consulting and Sunil Harji is a senior manager at Deloitte