Evaluating Bits and Bytes, Not Just Dollars and Cents
Chris Stafford and Keith Campbell featured in Middle Market Growth
Author:
Date : April 28, 2015
Key components of due diligence for tech industry divestitures
Industry:
As more innovative technologies and nimble startups enter the high-tech industry, a growing number of large, established corporations are choosing to divest tech-focused business divisions to refocus resources on the core business. For instance, late last year eBay announced its well-publicized split with PayPal, during which it divested the electronic payments division it bought in 2001 from the main online auction business.

Historically, however, these companies have not had the processes, playbooks or maturity to handle the complex separation process. Whether prepping to buy or sell a division, product line or technology asset, firms must take a number of precautions to uncover hidden areas of risk or quickly get to value creation. In preparing for sale, or throughout the due diligence process as an acquirer, organizations must consider these key areas to ensure a successful tech divestiture:

1. Understand the level of integration with the parent company for sales and marketing channels. More than just understanding the basic lead-to-close process, companies must also consider the overall maturity of sales management activity and reporting. Buyers and sellers should determine whether or not the target relies on the parent for brand equity, sales and cross-selling from the parent’s other products. Does the target have a channel partner program, and does it need to be “re-energized”? Consider also collecting voice-of-the-customer feedback during the market assessment. Addressing all of these questions is pertinent to the success of a divestiture in the tech sector and can reduce the risk of a revenue drop-off shortly after the separation.

2. Consider technology your pillar for efficiencies and the basis for new gains. To fully understand the cost benefit of a divestiture, potential buyers must dig deep to analyze the technologies and software included in the deal. The buyer should understand if patents have been awarded or if they are currently pending, and if full or partial rights will be transferred as part of the deal. The software’s domain is key to the separation—if it’s not included as part of the deal, the buyer will need to understand the downstream implications (both for the technology and for customers) if it needs to change.

A buyer should understand critical aspects of the software itself during diligence. For instance, can you be sure the technology’s performance, scalability and reliability will meet the new demands based on the growth plan? Additionally, many products these days claim to be software as a service; is the target operating on an out-of-the-box solution, or creating customized instances for each new customer? What is the expected capacity for growth using the current infrastructure? Buyers must understand how customizations are performed and the process for onboarding new customers, as these functions directly impact scalability.

These questions are just the tip of the iceberg around intellectual property protections and SaaS usage. Buyers should also pay careful attention to integrated software development processes, existence of open-source code (large company legal departments do not accept the use of open-source code), and how to retain critical technology staff from the parent through retention bonuses or other incentives.

3. Be diligent—even about back-office shared services—to minimize risk and cost. Often the largest cost of a carve-out is integrating shared services (HR, finance and IT) for the new company. To allow your focus as a buyer to remain on running and growing the business, make sure to fully understand the ways the target is reliant on the parent for back-office functions so you can identify costs and carefully execute the transition with minimal business disruption. In tech carve-outs, often the product technology itself is located at a data center shared with the parent. If so, determine if there are technical limitations or customer service-level agreements that would prohibit the buyer from bringing down systems for any period of time—if these exist, they may increase the one-time separation costs.

Without proper foresight and expertise, tech buyers and sellers can get into major trouble if they aren’t careful in the diligence process. By paying special attention to sales and marketing, technology and shared services, firms can ensure a smooth and successful carve-out. //

Keith Campbell is a senior manager in West Monroe Partners’ Mergers and Acquisitions practice. Chris Stafford is a manager in West Monroe Partners’ Mergers and Acquisitions practice.

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