An IT audit ought to be an integral part of the M&A process. It can unveil opportunities and highlight potholes down which it is all too easy to fall down.

When property management giant CB Richard Ellis makes an acquisition, you can be sure the “i”s get dotted and the “t”s crossed. And understanding a target company’s technology is always high on the agenda. Just confirming that you can get the IT right during the integration phase can be the difference between a deal creating and destroying value.

That’s why CBRE prefers to replace incumbent accounting systems with its own as soon as possible. “That way we can be sure we know what’s really going on,” says Andrew Self, associate director in charge of CBRE’s systems.

It’s a policy that pays off. In a recent deal, CBRE found that around 20 per cent of the claimed customer accounts in the acquiree’s database didn’t exist or were “dead”. Given that, when it acquires a service company, CBRE is only really buying the customers, it was quick to jump on the problem. That’s what warrants were invented for, we’re assuming.

Some will say this kind of customer knowledge failure should have been picked up as part of general due diligence. But as anyone who’s done this kind of thing knows, you only learn so much about your target in the pre-acquisition phase. And most of the data comes from their own systems.

In fact, IT audit is a three-stage process. For your due diligence to be meaningful, you need to know your target’s general systems are up-to-scratch and reliable – no company can truly say it’s operating effectively without strong IT in place. You need to know that its accounting and financial systems are generating reliable numbers. That way, your valuations and forecasts have proper justification. And you need to know that you can smoothly integrate its systems into your own IT set-up post-deal, whether they’re ops or financials.

So what can you do to hedge your bets when looking at IT systems in potential target companies?

Seek specialist advice

Increasingly, companies are turning to specialist IT due diligence advisers. This is in part a reflection of the complexity of M&A – you need experts in every area to get deals done in reasonable time – and partly thanks to the intricate nature of modern corporate IT. That said, many law firms and accountancy practices have also beefed up their IT skills to meet demand.

The problem is cost. “Clients want to pay as little as possible,” says Mark Leigh, partner with accountancy firm Roffe Swayne. “We understand that, but a technology audit is critical for all sorts of reasons. The problem is many deal-doers find IT something of a mystery and it’s always difficult to make commercial decisions about something you don’t understand.”

Robert May, MD of systems management firm Ramsac, warns that without conducting basic checks, acquirers can run into all sorts of trouble. “We often find that companies just don’t know things – such as the number of software licenses they legally hold, or the support arrangements for bespoke software – that might turn out to be business-critical.” And while these factors may not be deal-breakers, Leigh says they often have financial consequences. “When you’re getting down to the wire, IT issues can, and do, nibble at the strike price.”

Buying smaller companies

“While larger companies tend to have sophisticated accounting and management information systems, this cannot be said for many SMEs,” says Alan Webb, senior partner at the Yorkshire-based accountants Shepherd Partnership. “Records and systems vary from the very best to the most antiquated manual systems. In most cases, we’ll take a harder look at the records, since we know that many businesses struggle with computer systems.”

Doesn’t this unpredictability complicate M&A deals involving smaller businesses? Apparently not. According to Webb, a smaller acquisition tends to be either tactical, and so of secondary importance, or most of the information needed is all in one place (if not necessarily well-ordered). “Smaller acquisitions tend to be pretty intimate affairs,” he says. “You can get very close because there is often some kind of pre-existing trading arrangement that allows us close scrutiny.”

But on the numbers, Webb agrees with many others we interviewed. “A good financial accounting system supports the integrity of the financial statements,” he says. “The management’s willingness to invest in regular and reliable management accounts and other financial reports is indicative of a more attractive business.”

Medium-sized deals

Alchemy Partners is a private equity firm that specialises in reviving ailing companies. Often they’re medium-sized businesses that have fallen on hard times thanks to bad management or changing markets.

Jon Moulton, its plain-speaking managing partner, knows that assessing IT during M&A deals is never simple or straightforward. “In some cases – a mortgage-broking business, for example – the quality of the systems themselves is highly significant; in others, you place more importance on how they’re using the systems,” he says. “The more important the systems are to the business, the more you have to do.”

Not surprisingly, systems quality is especially important in the technology sector. When Alchemy portfolio company Cedar acquired financial software provider OpenAccounts, one of the drivers was Open’s business process and workflow expertise. “OpenAccounts was attractive to us for many reasons, but high on that list was its e-business technology,” says Mark Lane, Cedar’s product marketing and M&A director. Since the acquisition, he’s been able to take OpenAccounts technology and adapt it for other parts of the business.

Moulton doesn’t believe you can generate a single set of criteria and use that as an IT tick list in the deal. But judging from his experience, if you keep your eyes open, you’ll know problems when you see them. “For example, we look out for clapped-out call centres,” he says. “They’re not efficient and often explain why a company’s on the block.” In that sort of case, at least you know investment in technology could help a turnaround post-deal.

In any event, Moulton is firmly of the view that acquirers can get a good idea about target technology without spending forever talking to IT “propeller-heads”. “When I see someone wandering around with a 50-page report, I know they’ve got problems,” he says. “If you can’t tell management what it needs to know on one or two pages, you’re not homing in on the right things. You’re running an inefficient and ineffective business.”

Lane agrees. “IT develops in many different ways, so you do need a technology audit,” he says. “But technologists love what they do. That can mean more important issues become clouded.” And a common problem in mid-tier businesses is too much technology. “SAP is great for complex businesses, but it can strangle medium-sized companies,” says Moulton. “It’s overkill.”

Bespoke systems can be just as bad. While giants Wal-Mart, Tesco and other stellar performers rely on their in-house, proprietary systems, smaller companies don’t have the IT expertise and infrastructure to make bespoke systems pay off. In one case, Alchemy found that home-grown systems contributed to massive differences in reported and actual inventory. “The company was in the ridiculous position of having inventory provisions that were larger than the physical stock count,” he says. “They had no real idea what the figures meant and they bore no relation to inventory anyway.”

Poor IT can be a liability post-deal as well. IT integration projects are fraught with risk, especially when you factor in “change management” issues. This is compounded by the other pressures in an acquisition. So it’s a judgment call as to what you can reasonably achieve in the immediate post-acquisition period without completely ripping the value out of the acquired business. It takes skill, experience and the ability to apply a light touch at a time when employees feel most vulnerable.

Big businesses

At the top end of the market, the stakes are that much higher. Deal values are
massive, the technology set-ups of both acquirer and target are likely to be complex and the information you need during due diligence overwhelming. If you’re used to getting great information from your own systems and find your target’s IT just can’t deliver reliable KPIs, you’ve got a potential nightmare in store.

A technology mismatch can spell disaster. Look at the situation at beleaguered Morrisons. It’s thought that while Safeway had a superior supply chain system, internal wrangling over what technology to use post-deal has contributed to the
current mess. But the situation is not unusual: large organisations have come to rely on technology. As a result, IT departments have become powerful, often to the point where their decisions and opinions carry more weight than yours in finance.

The rise of the chief information officer (CIO) in big business has complicated things. They often understand the technology. But M&A deals involve a lot more upheaval than setting up the right systems. Andrew Morlet heads up Accenture’s strategic IT unit. “We find that CIOs have no direct or coherent structure for managing the HR aspects, so often they have a limited understanding of the IT workforce,” he says. “At a time when there is a high level of change, perhaps including a strategic shift to outsourcing, CIOs find it tough to manage geographically dispersed workforces – and after a deal that enlarges the company, that can be challenging.”

At the same time, large-scale M&A deals require rapid assimilation of customers and early value capture. “The focus now is on revenue-oriented benefits – but it’s hard,” says Morlet. “Those things require strong integration, both of people and technologies.” The paradox is that while most boards understand the value of bringing IT departments together, Morlet believes boards only expend a small portion of their actual effort on systems integration.

What should you do?

Just think of IT systems and the data they carry as corporate assets and treat them as such during the deal. You wouldn’t buy a company with significant property assets without undertaking a valuation – so why should IT be any different? What aspects of the IT you investigate – their compatibility with your own systems, the reliability of the data, how well financial and operational systems work together and so on – will depend on a number of factors:

- The industry you’re in – a property company is less reliant on IT than a retailer.

- The ability of your current IT people to tackle the target firm’s technologies.

- Your forward IT plans – how the acquired company’s systems might complement them or whether you can force your new strategy onto their business as part of the integration.

- Your perception of IT risk – especially where it ranks against financial or legal risks.

- Experience of past acquisitions – do you have someone expert at quickly assessing the reliability of a target company’s systems?

- The time and cash you’re prepared to commit. This can’t be an afterthought.

And if you decide to buy:

- Send in a tech audit team with deep understanding of the target company’s IT.

- Develop, and use, a risk assessment matrix. For example, if you ditch their procurement system and move their operations onto yours, what are you going to lose?

- Select the best from existing and acquired technologies. The right decision could be to roll your operations into their systems.

- Execute a clear transition programme. And project manage it carefully.

- Train and educate for change. There are no easy answers, but you can’t just hope your people will all “get along”.

In short, IT due diligence must be on the to-do list when you’re scoping out acquisition targets. And IT integration must be high up the list after you’ve done the deal.

Dennis Howlett is an accountant, consultant and former FD.

The FD's view: post-deal systems integration

Ian Cray was CFO at United Biscuits (UB) from 2001 to 2004 and is a former treasurer at Diageo. In his time at UB, Cray was involved in several M&A deals, including a number of disposals, the acquisition of Portuguese company Triunfo Productos Alimentares and the purchase of Jacob’s biscuit group from Danone.

“Depending on the industry, you either have a significant amount of work or comparatively little post-deal,” he says. “In consumer packaged goods, for instance, you can overcome many problems by running in parallel, if the plan is to integrate at some future point. Retail is a different story, where IT is much more critical.

“The human factors are frequently underestimated and yet these are at the heart of what makes an M&A deal successful. The same principles that apply to retaining management apply equally to those involved in business-critical IT departments. The key is getting the new company ‘on board’ with the acquiring company’s culture. You need to capture the organisational beliefs about how life will be better. Everyone will be concerned about the impact on jobs, so transition planning has to be in place. If you don’t have a systems steering group, it will leave IT departments in a position where they create their own future. That will spell trouble down the road.”

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