Giving digital diligence its due

majdigitaldiligence

In today’s M&A landscape, the definition of due diligence must expand beyond conventional financial metrics to include a company’s digital strategy and capabilities strengths and weaknesses as well.

Traditionally, due diligence has focused on examination of the assets, liabilities and overall fiscal health of the target company. That will continue. Financial statements, quality of earnings reports, commercial diligence and legal are the backbone of the diligence process.

But investors must now extend their M&A due diligence to include “digital diligence.”

In our digital economy, every company is a technology company—which means every company lives and dies by how effectively it embraces technology and protects itself against cyber threats. That means acquirers need to take a hard look at everything digital to see if the target company has a true tech strategy in place.

In addition to pinpointing tech risks and shortcomings in potential acquisition targets, digital diligence efforts should identify areas of opportunity that may drive up the value of that asset post-close through improved use of information technology.

For many years, it was common practice for buyers to examine a target company’s IT infrastructure only after the deal closed. This often led to unforeseen expenses, because acquirers realized too late that they would have to invest in new hardware, software and services to scale the acquired business and make it more competitive in the marketplace. Only over the past 10 years has some level of IT diligence become mainstream.

Today, it is even more critical for acquirers to assess the suitability and scalability of all IT systems at the target company—including customer engagement, sales, finance, manufacturing and HR applications—and assess whether they’re modernized, well-implemented and integrated.

Even more important, acquirers should ascertain the degree to which a target’s IT strategy is aligned with its corporate strategy and whether it’s a core part of the organization. This involves digging deep, beyond a look at what ERP system the company has implemented or which networking vendor it’s using. Acquirers must investigate how the target company is leveraging ecommerce, social media and all aspects of digital to drive its business and create proactive relationships with its customers and suppliers.

That’s because effective use of digital can be a major growth multiplier for the combined company. We worked with one acquirer targeting a company that, while smaller, was enjoying much higher revenue growth and better customer retention when compared to its larger peers. As part of the digital diligence process, we set out to discover how it was accomplishing this.

It quickly became evident that the target company was light years ahead in using social media to engage with customers and in leveraging automation to stay connected with its client base post sale. The acquirer recognized that the target company could help jumpstart its own digital strategy to drive business rapidly forward. This was a case where one plus one actually equaled three or even four.

In the past, identifying opportunities for digital innovation within a target company was not a high priority. Today that attitude is changing, because acquirers realize that innovation, properly applied, can transform an average company into a great one. It could be something as simple as an enhanced internet presence, such as the introduction of a web-based interface that allows customers to check inventory and place their own online orders.

An obvious yet fruitful innovation like that could bring all sorts of benefits: lower customer-acquisition costs, improved customer-relationship management, reduced selling and marketing expenses, and much more. In other words, the proper digital diligence can add significant value to any acquisition and lead to a substantial return on investment.

Companies’ increased reliance on emerging digital technologies adds another new and necessary layer to the due diligence process: cyber diligence. After all, cyber breaches are increasing in size and scope, and companies of all sizes need to be more prepared than ever before.

A cyber diligence assessment should be coupled with any technology diligence and should examine vulnerabilities in the target’s IT assets and the scope of damage that could occur in the event of a breach. While cyber diligence might not always deliver complete assurance of the target company’s ability to protect and defend against cyber threats, it can provide a reasonable understanding of the target company’s current capabilities.

For example, how is the target company currently monitoring threats? What kind of response plan does it have in the event of a cyber attack? How quickly can the company recover if an attack disrupts its supply chain or its ability to get products to market? A proper technology focused diligence effort will raise a number of vital questions—and, depending on the answers, it will impact the way a deal is structured and valued.

Due diligence isn’t what it used to be. It’s no longer just about identifying risks that reside in an acquisition target. Now it’s also about uncovering areas of opportunity that may drive up the value of that asset post-close. Done well, technology diligence with a focus on digital and cyber can lead to greater returns and more successful acquisitions.