7 Things to Consider in IT Due Diligence

IT due diligence is too often overlooked when it comes to lower middle market acquisitions.

We wrote recently about the benefits of having an IT professional on your M&A deal team. “Business today is increasingly IT dependent,” John Beauford, director of IT at Doctors in Training, argued. To mitigate risk, “involve IT professionals as part of the deal team to help assess a broad overview of the IT landscape of the target firm and identify any substantive issues that may exist early in the deal making process.”

Whether you have a dedicated professional, here are a few specific things to think about when it comes to IT due diligence.

1. Determine the technology’s compatibility. If the target company uses leading edge or proprietary technology, it may not integrate easily, if at all, with an acquiring company’s legacy systems. This can have serious ramifications for the integration of the companies, the maintainability of the software and the retention of key employees at the target company.

2. Verify that the technology can be supported. This includes basic things like whether or not the target company has a clean copy of the source code for their technology, or whether they own the rights in the first place. These issues come up more often than you might think. Even if there is a viable copy of software source code and all ownership rights are in order, are the people who wrote the software still employed by the target company?

3. Uncover licensing risks. It’s not uncommon to find that a smaller tech company has not properly licensed all of it production or development software. Additional licensing costs may eventually come to light.

4. Establish the technology’s scalability. How will the software or systems behave if the number of customers doubles or increases tenfold? Will the technology expand gracefully with a low marginal cost, or require a large investment in new servers or other hardware? In the worst-case scenario, a complete re-architecture of the technology may be required. These costs should be included in the terms of the transaction.

5. Identify the key employees associated with the technology. Interview some or all of the target company’s technology staff. Get a good feel for the personalities involved. If the company is being rolled up into a larger company, will they work well in the new organization? If retaining these employees is important, employment agreements or retention bonuses should be put in place to be sure they remain post-transaction.

6. Examine current resources. Many smaller companies scrape by with minimal resources when it comes to things like networking and other IT infrastructure. Has the target company put off making needed investments in order to artificially inflate profitability? If the systems are noticeably outdated, you could be walking into a large front-end investment that should be included in the sale price.

7. Identify opportunities for cost savings. Technical knowledge is needed to determine realistic synergies. Don’t assume that you’ll be able to combine data centers just because both the acquiring and selling companies have them. Are the technical platforms compatible? Does the target company’s IT staff have the necessary technical skills? Are there overlaps with the acquiring company’s staff? Confirm synergies to avoid sunk costs and to maximize benefits from the transaction.