MAKING TECH ACQUISITIONS WORK
For technology companies and entrepreneurs operating in the broad sphere of “technology” (from SAAS to ecommerce, ad tech to ed tech), acquisitions are always front of mind. In these sectors M&A is not an afterthought, it is essential, argue McKinsey’s Tanguy Catlin and Brett May. But with unusual valuation metrics, and high competition for acquisitions, the risk of getting it wrong can be high for the acquirer. In this article the authors share examples of acquisition pitfalls to avoid, based on real-world examples from even the most sophisticated acquirers. The lessons can be useful to acquirers at all levels.
STRATEGY
Catlin and May argue for a clear strategy before starting the search for technology acquisitions. There is often a play-off between the competing goals of commercial scale, speculative innovation and cashflow. Articulating a clear strategy before starting a search and for effective evaluation of deals, along with a clear view of how acquired products and services would integrate with the acquirer’s existing offering is essential for successful deals.
An unfortunate example cited by the authors of the acquisition of a profitable software company by a technology service provider. The profits of the target company derived largely from a single mature product with little strategic value to the acquirer, and the technology solution that was originally of interest turned out to be a niche product with limited market size and potential. While innovative, the product didn’t meet both the innovative and scale goals that it needed to make it a successful and worthwhile acquisition.
DUE DILIGENCE
Technical due diligence is essential when evaluating a technology acquisition. Evaluation of how the technology will perform inside your organisation and under real world constraints is crucial for an acquisition to be a success. Effective due diligence can uncover cases where the technology doesn’t work as advertised, only works in limited environments or has undesirable constraints. Catlin and May describe the case of a healthcare equipment manufacturer purchased an imaging technology company with sophisticated code that worked on a stand-alone basis, but was ultimately incompatible with the acquirer’s technical architecture.
In addition to the technology working as expected it is also important to review IP ownership: it can be the case that the crucial IP not wholly owned by the seller. The McKinsey article describes the case of a communications hardware manufacturer that acquired a remote network monitoring software company. While the product was good, the software code it relied on was only licenced, not owned, by the acquired company. In addition to this, the code was itself acquired by the hardware company’s competitor and as a result the code became unavailable. Development of the missing IP code cost of tens of millions of dollars and a 24-month delay.
The ability to carry out a thorough vetting of the technology can be constrained by deal confidentially requirements and discretion concerns where access to key engineers may be available. Technology due diligence is also difficult when the expertise to validate doesn’t exist in-house.
VALUATION
While it is always important to not get the valuation wrong, technology valuations require understanding of value from a range of perspectives, the value to the acquirer and the market. Valuing technology companies purely by traditional M&A valuation methods are often not sufficient and provide an incomplete picture. Combining a number of valuation methods to evaluate technology company will provide a better picture of the acquisitions worth. As Catlin and May correctly point out, EBITDA multiples don’t make sense when evaluating an early stage startup where metrics such as multiples based on the number of subscribers may be more useful.
INTEGRATION
The post-acquisition strategy and integration work is hugely important to the success of a technology acquisition. From talent retention to focus and pace of integration implementation. If done poorly, acquisition implementation can ruin even the most promising deals. An example from the McKinsey article highlights the importance of acquisition integration. A deal in the energy software space, when the parent company was under pressure from macroeconomic forces shortly after the acquisition, the operating budget to integrate the acquired company was reduced. As a result, it underperformed on its commercial targets and eventually led to the write-off of the acquired company.
Successful technology acquisitions can have transformative implications and benefits. This article highlights some examples of where they can go wrong, as a guide to pitfall avoidance for future acquirers. Having a clear strategy during the search as well as the expertise, knowledge and focus at all stages of the acquisition is key to avoiding potential risks and making the deal succeed.
ABOUT HAHNBECK
Hahnbeck is an M&A consultancy specialising in acquisitions in the £2m to £200m range. We help our clients to make off-market acquisitions of targets with good strategic alignment that add real value. If you are looking to grow through acquisition please don’t hesitate to get in touch.