If the IT infrastructure is fine, why conduct due diligence?
Difficult economic times have greatly reduced acquisition deal flow across the private equity sector. It appears this change in economic landscape has influenced many firms to take a much closer look at both their pre-acquisition targets and their existing portfolio companies. Information technology Infrastructure traditionally receives less attention, which is a surprise, considering the difficulty IT organizations are having due to ineffective systems. The IT infrastructure is a very common cause for significant issues within portfolio companies. These issues result in bottlenecks that restrict growth and are very costly to address. Therefore, we feel private equity firms should pay much closer attention to IT in an effort to understand the technical environment when purchasing a company.
Due diligence on IT Infrastructure is a key process that may be overlooked, whether acquiring a platform company or add-on acquisition. Taking the appropriate steps to analyze the challenges will undoubtedly save time and money in the end.
The IT diligence process will identify any red flags, such as aspects of the IT infrastructure that would put the acquisition in question. Typically, the cost to rectify the situation is significant, making the financial viability of the acquisition unacceptable.
Once beyond the red flags, it is important to identify opportunities to improve business performance. When the system does not meet key requirements, the business, in one form or another, is not performing to the level it can or should. Improvements come in many forms, and can include revenue improvement, cost reductions, cost avoidance, and improved customer service. It is important to note, although you should look at technology, the process is about facilitating business performance. Therefore, it is important to understand to a relative level of detail, how the business operates from end-to-end.
Although deal flow is significantly reduced, based on our observations, the percentage of add-on acquisitions to platforms is significantly higher than in the past. Obtaining debt financing is easier for add-ons.
Integration Challenges
When evaluating add-on acquisitions, it is important to understand how the new organization will integrate with the platform business. This is the first step in understanding and aligning the IT infrastructure to the needs of the future business model. The diligence report needs to go beyond diligence on the operational flow and technology of this acquisition candidate. A holistic approach that anticipates the combined entities is critical. We believe the diligence report should have a high-level integration plan that will serve as the foundation of the detailed acquisition integration plan. Although the ultimate plan will not be developed until after the diligence, it is important to have as much of the premise and directional themes in place from the beginning.
Obtaining a detailed perspective of the current state of the acquisition candidate’s IT infrastructure is important. A superficial or checklist perspective is not enough; the devil is in the details. Many private equity firms have experienced minor to major surprises after acquisition. It is important to quickly obtain a perspective of the IT infrastructures of the businesses coming together. Don’t wait until the acquisition takes place to start learning.
The analysis includes determining the longevity of the current IT platform. How long the current platform will last is directly dependent on the direction of the business. This requires input from both the acquiring private equity firm and senior management of the platform business. Their business strategy and overall growth plans will answer the question. Growth affects the number and types of business transactions a business will have. Ultimately, this will affect all aspects of the information systems infrastructure.
When reviewing companies, we frequently find business management dissatisfied with the capabilities of their current application portfolio because workflow is inefficient and it is difficult to obtain business performance information. Our experience has shown the situation is not always as bad as it appears. Eight out of ten times, what appears to be a bad situation can be greatly improved through basic pragmatic solutions. Details are important, comments are not enough, and you need to find out what the situation is. In many cases, the perceived problem is not the real problem.
Knowing when and how much to invest is always a difficult question to answer. What are the thresholds/triggers for investment? The simple answer is when it makes business sense, and any investment has to provide the appropriate value, which is ultimately determined by the return on that investment. Although the diligence is not a strategy or a plan, it does need to provide a high-level direction. Time needs to be spent understanding the overall business strategy, objectives, priorities, and operational factors. These business factors should be compared to the capabilities of the information technology infrastructure. These conversations will begin to formulate a straw-man direction.
The required investments will be predominantly driven by areas where the systems are falling short. Once those gaps are understood, technology solutions/approaches can be identified and investment requirements determined. At some point after the acquisition, a more detailed analysis will be necessary. This could potentially include the development of an IT roadmap with a business case that will ultimately sort out the options. This will provide the answer when and how much to invest.
As mentioned earlier, the diligence should include a high-level integration plan. Once the acquisition is complete, the detailed integration plan needs to be developed. The integration plan focuses on how to bring both the business operations and the supporting information technology environments together. Typically, management of the acquiring company and the private equity professionals have a well thought-out perspective to consolidate departments, as well as those areas that will remain as is. The degree to which the companies come together is a key factor in defining the information technology infrastructure.
A common mistake is to assume the businesses have to be on the same application platform. If both businesses have adequate systems, and the businesses have limited interaction, it may not be necessary to be on a common platform.
Re-Implementation
When it makes sense to integrate the businesses, a common application portfolio is frequently a logical conclusion. Leveraging one of the two companies’ application platforms is a pragmatic approach to implementing common systems. This can even be true in those situations where both companies are not satisfied with their current platform. We say this because typically the portfolio companies are not aware of the full capabilities of their system. Therefore, it is less about the capabilities of the software and more about how it was implemented. Some detailed analysis during the diligence process will provide this answer. We call this a re-implementation. Without diving too much in the details, this approach can include some or all of the following activities: upgrading to the latest version of the software, redefining workflow to better leverage the capabilities of the system, additional modules that are part of the ERP system, add-on (3rd party) modules and training. More often than not, we find a re-implementation is the right solution.
Re-implementation has many advantages. The risk is significantly less because one of the organizations is already using the system. With this approach improvements are implemented incrementally, one business function and corresponding module at a time. The overall cost of a reimplementation is significantly less as well; the cost is a fraction of a completely new system selection and implementation project.
The question is, do you reimplement yourself, or seek assistance from a consultant? Our standard answer is that if you have the skills, experience, and time, then utilize internal resources. If there is a void in one of these categories, pursue help from the outside. Find a firm that has experience working with private equity-owned businesses, along with relevant portfolio company industry experience. This is our bias, but make sure they have the right balance of proven approaches. They should not be so formal that the effort and cost are too high because of needless paperwork and process. Do your homework. Check their references, and make sure they have a solid reputation in the private equity community. Check with portfolio companies as well. Work with a firm that will partner well with the team. Select a firm that provides you with options, demonstrates pragmatic approaches, and is trustworthy.
It is very important to have a thorough information technology review as part of your due diligence process. This exercise should not be a high-level check-the-box review; get down to the details. Always review the business direction and operations; they are the key drivers for your information technology direction. First, determine if there are red flags, and then look for opportunities to improve the business by better leveraging technology. When looking at add-on acquisitions, understand how the businesses will be coming together. If the businesses are going to be closely integrated, look to leverage one of the two organizations’ application portfolios. Don’t assume on face value the systems don’t meet the current needs and can’t support the future direction. More often than not, it is not about the capabilities of the system, but how it was implemented. If you need a consultant, make sure you choose the right firm.
John H. Bisack III is president and managing director of Performance Improvement Partners, responsible for strategic direction, new business development and client satisfaction. Reach him at jbisack@pip-llc.com.
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