December 09th, 2021 – Reading time: 7 minutes

Software rules the world, and its kingdom is growing

By Stefan J. Marquart – INVENSITY; Hanno Hepke – Warth & Klein Grant Thornton, David Stelzer – Warth & Klein Grant Thornton

In an increasing digitized world, software solutions have become omnipresent in our businesses. Companies which are related to software and technology are booming. In every event like the Corporate M&A event in Munich you can hear the same credo: “One of the major industry drivers are software & technology”.

1) The number of software & technology related transactions and their valuation are increasing

Over the last years we recognized a dramatic shift in the M&A market. The volume and number of software related transactions are rising as well as their multiplies. Non-technology companies, Private Equity & Family Offices are helping to fuel the hot market even more, as they join the traditional technology players in pursuing software companies.

2) The value creation in companies is shifting towards software

From a buyer’s perspective, the software & technology related industry is attractive because of several factors:

• A large and growing industry with annual growth rates of more than 10%
• Recurring revenues streams like annual subscriptions or licensing fees
• High potential for scaling because the product development and its sales are independent form each other
• Customer stickiness is high and churn rates are typically quite low due to the high switching cost for customers
• The number of potential targets is high, the industry is fragmented and offers the potential for consolidation.

3) Key elements of a technology oriented Due Diligence

It seems that the sell-side are using the same “buzzwords” as artificial intelligence, IoT or digitalization in their Information Memorandum to get more attention at the market. Moreover, the buy-side is sometimes lacking the capabilities to understand the opportunities and threats of software companies.

From a buyer’s perspective, the three most important factors to look at a Due Diligence are:

1. People as assets because they are ones who create new technologies and software
2. Processes and artefacts are the key elements to secure and transfer the knowledge
3. Product architecture, software code and IT infrastructure reviews help to identify risks and opportunities

a) People are the ones who create new technologies and software

During HR due diligence, internal processes, functions and the corporate structures play an important role because they reveal information such as:

1. How is the development team organized?
2. Who are the key employees?
3. What skills and capabilities do they bring with them?
4. What areas of responsibility do they oversee?

Companies must have a clear view about the competences they need to transform their business. Unfortunately, this is not always the case.

b)  Development standards, processes and artefacts are the basis of benchmarks 

Development standards, processes and artefacts are the only possible of a company to secure their knowledge, make it less people related and transferable to other people or organizations. Furthermore, it gives the opportunity to benchmark the capabilities of a company within or across industries.

During a due diligence the most important questions to ask are:

1. What kind of development processes and tools do they use? (e.g. Agile, DevOps, CI / CD)
2. How is the R&D/Product organization compared to industry best practices?
3. What kind of international or regional standards are relevant and how are they achieved?
4. Assess of development artefacts from the e.g. (A)SPICE standard
5. Are there potential limitations on scaling, maintaining, and extending the product?

c) Software and infrastructure are the main asset and should be part of every technical due diligence

In every Software and IT infrastructure you get the chance to learn about the history of a company through technical & development capabilities and debts as well as insights about possible future values and growth opportunities.

Software and IT due diligence reveal information such as:

1. What technology stack and architecture is used?
2. Are current development standards met?
3. Are there scaling limitations?
4. Is the software stack state of the art and are there any technical debts?
5. What is the quality and documentation of SW source code?
6. Is it possible for any other SW team to take over SW development and maintenance?

4) Conclusion

The software market offers a lot of opportunities for technology companies as well as financial investors. Unfortunately, the investors are sometimes missing the capabilities or understanding of the risks and future possibilities of the companies. To get a better understanding about the target, the buy-side should investigate into three elements a) people, b) processes & artefacts and c) software code and infrastructure.