Contact

10 keys to due diligence in the ICT sector


Integral service around a transaction
BY : Diego GutiérrezJuly Thu, 2013

dd ticLa due- dilligence es una pieza clave en todo proceso de compra-sale of companies. Su objetivo es validar toda la información que se ha suministrado al comprador. Cada sector tiene sus peculiaridades y el sector de IT no es una excepción. Os transcribo 10 observaciones que hace la empresa McGaldrey experta en servicios de DD en el sector TIC. El año pasado realizó más de 150 DD de empresas de software y hardware.

1. Complexities with software revenues:

Software revenue recognition remains the most common and most complex problem in the IT industry. The concepts are very difficult to understand and equally difficult to apply. The easy part of software revenue recognition is that even if it has an impact on EBITDA impact and reported revenue, it does not affect the timing of cash flows.

2. Staged proceedings:

Buyers and sellers are performing more due diligence and identifying major issues early. We are frequently asked, to phase our diligence, to first address the areas of revenue recognition (deferred revenue) and sometimes capitalisation of software development. If these issues pass muster, we are then asked to analyse the quality of earnings.

Software or SaaS:

Is the business to sell software or SaaS model services? There is sometimes confusion about this question, especially now that many companies are selling both alternatives. The accounting issues are very different depending on the answer.

4. SaaS installation costs:

It seems natural to think that revenue is recognised when services are delivered to customers. That couldn't be further from the truth when setting up or implementing a SaaS Client. Instead, suspend rational thinking and recognise configuration revenue over the length of the contract term and the estimated length of customer relationships, this may mean that instead of recognising configuration revenue in the first month or two of a contract, it could be recognised over the next seven years, if the customer is expected to have this period of relationship.

5. What about the hardware?

Considering the level of knowledge, we often encounter surprises when inventory and cost of sales are sometimes incorrectly recorded in hardware companies, as they are often overlooked in order to focus on the most common risk areas.

6. Deferred "haircut" income:

The concept that deferred revenue may fade or receive a significant haircut as a result of the transaction is difficult to understand. Generally, deferred revenue in the closing balance sheet of the oldco jumps off a cliff with the accounting application of US GAAP purchases in the opening balance sheet of the newco. For accounting purposes, deferred maintenance, subscriptions or implementation revenues are reduced to the cost of providing the service, plus a reasonable margin. The buyer must understand this concept and apply it in modelling future revenues and earnings, as well as the structure of the loan covenant (if the transaction is leveraged).

7. Capitalised software development costs:

Investors want to know what the company's EBITDA looks like with and without the capitalisation of software development costs. A common misconception is that management teams sometimes fail to recognise that the accounting treatment representing capitalisation of software development is typically different for software companies and SaaS companies.

8. Working capital or an effective exchange rate for labour:

The idea of stagnant working capital seems old hat today, but it is highly nuanced in the ICT industry, due to the treatment of deferred revenue, where the focus is on its life cycle and seasonal accounting. If deferred revenue has historically not been recorded in accordance with US GAAP, designing or establishing working capital and its subsequent resolution can be very complicated. We work with investors who run the gamut for the treatment of deferred revenue with respect to working capital, from excluding it entirely, to adjusting for the cost of providing future services (see observation. 6), to including the entire lack of adjustment. In the absence of good benchmarks for establishing working capital, sometimes the solution lies in estimating cash instead.

9. Sell-side due diligence:

As the process for selling a business becomes increasingly standardised, sellers are increasingly including sell-side due diligence as part of the process. Sell-side due diligence helps uncover unknown issues that buyers are involved in (e.g., recognition of software revenue), supports or enhances the value of the seller's proposal, and helps decrease the risk of a deal breaker.

10. Taxes really matter:

The tax ramifications on financial diligence and quality of earnings are particularly severe in the software industry. Rules and regulations for sales taxes, which must be included in EBITDA, can vary from state to state or country to country. If a company cannot recover taxes from customers, the corresponding amounts should be considered a reduction of EBITDA or at least considered a debt similar to an account payable (with interest and penalties) by the vendor at closing.

The M&A Professionals

Meet our services

MEET
OUR
METODOLOGY

Do you want to be up to date?

SUSCRIBE OUR NEWSLETTER

Our diferentiation

Market Research Technology
Our team of market analysis specialists is continuously analyzing the investments of the most active markets in the industry in order to unceasingly contribute ideas of the current market situation and identify the most relevant trends for senior management. We integrate the most relevant sources of information which allows us to discover the most interesting companies for venture capital and similarly helps us to identify the investors with the highest probability of involvement in an M&A process to ensure the success of our sell-side operations.

The reports and deductions of our advisors provide a broad view of the sector, both geographically and from the complementary or adjacent markets perspective.
Technology Data Analytics
for M&A
Advanced data anlytics is a weapon". Intelfin is an artificial intelligence tool we use for investing and creating value in SMEs through competitive analytics and the enterprise environment.

IntelFin consists of a cognitive system, which, through the application of advanced analytical technologies, facilitates the automation of investment and financing decisions in the field of non-listed companies and especially SMEs in high-growth sectors.

The information related to these companies is characterized by their lack of transparency and heterogeneity; thus, it is necessary to develop an advanced analysis which is as much predictive as prescriptive and is developed in a natural language custom, suitable to obtain greater clarity and knowledge of the investment scope.

The IntelFin system focuses especially on analyzing the variables that define and influence the competitive environment of a sector and the positioning of a company, analyzing their influence on future value creation. Therefore, IntelFin supports strategic decision-making to senior management by resolving questions such as:

¿What are my competitors' priorities, strategies and expansion plans? Who's my competition? Which competitor is most likely to grow at a higher rate?
Which areas of activity/business models will receive the most investment? Which sectors are most attractive to investors?
Which companies are going to experience the most growth in the near future? Which companies are most likely to receive investment or be acquired?
Training Methodology
We have developed training programs in an innovative set-up which guarantees our teams the acquisition of technical competences both in the field of corporate finance and in the field of psychology, that is much needed when it comes to negotiation processes.

We have a culture of continuous improvement of our processes, closely related to the use of information systems that allow the enhancement of internal communication between our teams, as well as external communication with our customers. Hence, we extend best practices identified internally in an efficient and rapid manner among our members.

Are you one of those who prefer to be well informed when making decisions?

M&A NEWS
INDUSTRIAL REPORTS
closearrow-circle-o-downchevron-downcrossmenu