Due diligence is a fundamental stage in every M&A transaction and lays the foundation on which a deal is built. However, with so much material to review, companies sometimes don’t pay enough attention to information technology (IT). Not only is this risky from a legal perspective, but it can also negatively impact business success. According to research conducted by Ernst and Young (report available here), nearly half of dealmakers surveyed admitted that more detailed IT due diligence could have reduced the amount of lost value in an M&A transaction.
One of the issues is that IT may not always appear to be a significant component of the deal. However, IT systems are usually quietly operating in the background of virtually every major business across industry groups, not just today’s modern technology companies. For example, a manufacturing company may simultaneously use enterprise resource planning (ERP) software to bind together critical business functions (like product planning, inventory and sales) and customer relationship management (CRM) software to manage customer interactions through the sales cycle, not to mention any standard software and IT systems required for typical office functions such as email and word processing. Often, these systems are expected to run seamlessly on day one after the deal is completed, to enable the M&A transaction’s cost-saving and revenue generation opportunities to be realized.
However, deal makers don’t always put in the effort required to understand the target company’s IT systems, or their own. It’s critical to evaluate from a legal and technical perspective how the IT systems of the two companies will work together and factor these considerations into the M&A process early on. There are many questions to consider, including whether existing IT systems are well-run and produce accurate results (otherwise, due diligence information may not be adequate), whether there are any significant IT implementations planned for the future, whether there are any performance issues with software vendors, and whether all pertinent IT information and documentation have been disclosed.
From a legal perspective, IT contracts can vary widely, ranging from a large vendor’s non-negotiable standard form to one-of-a-kind agreements designed for a particular implementation. In both cases, in addition to considering typical legal terms such as those relating to the allocation of liability, change of control and assignability, it is also critical to evaluate the commercial and technical arrangement established by the agreement and how that fits with the proposed M&A deal. There are many common pitfalls to consider, such as individual purchase orders and statements of work that have not been properly disclosed and reviewed, and the incorporation of additional terms and conditions by reference.
As the common saying goes, the devil is in the detail. When it comes to IT due diligence, it’s important to have the right teams in place, including business, technical and legal professionals to properly evaluate those details in order to achieve M&A success.