Software deal experience
If the company doesn’t have a lot of software deal experience, you should prepare for important differences in commercial due diligence. To illustrate this, suppose an industrials company is weighing whether to acquire a SaaS business. Ordinarily the company would evaluate factors such as:
- Current market size
- Macroeconomic growth drivers
- Competitive intensity and positioning
- Purchase process and key purchase criteria
- Operational synergies
But for a software company, these factors are insufficient at best and poor indicators of value at worst. A potential buyer will also need to assess attributes like:
- Total addressable market
- Market penetration growth
- Migration J-curve marking the valley between traditional perpetual licensing and a subscription-based model
- Ratio of customer lifetime value to customer acquisition cost
- Customer churn rate
- Net revenue retention
And the differences don’t stop there. The potential buyer will also need to answer vital diligence questions such as whether the code is scalable, what rights the acquiring company would have with the data and what the exposure to cyberthreats would be.
Justifying the deal
When it comes to software, one way to justify a deal is to determine whether the potential acquirer has the “right to own” it. There are two ways of looking at this. One is to determine the benefits to the acquiring company versus other would-be suitors, which could include other industrials firms, software businesses or even private equity buyers. If the acquiring company stands to benefit more than other potential buyers — the acquirer would get more benefit out of new vertical exposure, for example — then that could help justify the acquisition.
The other (and more frequently overlooked) way to evaluate the right to own is to spell out the benefits that the acquiring company brings to the target versus other possible owners. For example, software targets’ high multiples often reflect their growth potential. An industrials company may be able to fuel that growth by offering a large installed client base, unique domain expertise or other attributes that other potential owners can’t match.
Culture and talent
In a 2018 survey, L.E.K. asked respondents from industrials firms about the top barriers to implementing new digital capabilities and technology in their organization. The most common barrier was the lack of digitally capable talent, followed by organizational alignment and structural limitations.
In failed post-merger integrations, the latter can give rise to the former. It often comes down to a culture clash between the acquired company and its new owner, making it hard to operate effectively and prompting talent to seek opportunities elsewhere. To head off an outcome like this, consider taking the following steps:
- Recognize that not all talent is created equal (software engineers are expensive)
- Support remote work as a recruiting and retention tool
- Emphasize the benefits of the business combination and how the acquiring firm provides a new “launch pad” for the software company
Depending on the circumstances, it can be better to maintain the acquired company’s independence. That way, the culture that contributed to the software company’s value can stay intact. This approach also helps maintain a critical mass of talent and redundancy. Finally, separate profit and loss goals may be more in line with investment needs and performance expectations.
