Technical debt is an often invisible but increasingly significant risk in mergers and acquisitions. It refers to the burden of suboptimal technology decisions, made by the target business in the past, that now require substantial costs and effort to fix. 

Technology debt can manifest itself in various forms, including outdated applications, system architecture and poor code quality. These issues can lead to increased security vulnerabilities, as well as impede growth and integration efforts. Understanding and addressing technical debt during the technology due diligence phase therefore becomes crucial to ensure the success of an M&A transaction.

The impact of technical debt on M&A transactions

1. Valuation challenges: Outdated legacy technologies, poorly maintained code and inefficient processes can lead to higher maintenance costs and reduced scalability. These factors can lower the perceived value of the company, making it less attractive to potential buyers – especially if technical debt factors have led to regular outages and service issues.
2. Operational risks: Technical debt can introduce operational risks that may not be immediately apparent. For instance, security vulnerabilities in the codebase and the inability to patch outdated systems can expose the company to data breaches and compliance issues. Additionally, inefficient development processes can lead to project delays and budget overruns.
3. Integration difficulties: Post-merger integration is often complicated by technical debt. Incompatible systems, undocumented code and lack of standardized processes can hinder the seamless integration of the acquired company’s technology with the acquirer’s systems. This can lead to increased costs and delays in realizing the expected synergies from the acquisition.
4. Separation and standalone operation difficulties: Technical debt can make the already hugely complex task of separation and establishment of standalone operations even more challenging. There is also the risk of hidden costs and extended TSA durations that were not planned for based on diligence findings.

Avoiding or mitigating the impacts of technical debt in M&A

1. Comprehensive due diligence: Conducting thorough technical due diligence is essential for identifying and assessing technical debt. This involves evaluating the target company’s system architecture, code quality, and development processes. Engaging experienced technical experts can help uncover hidden liabilities and provide a clearer picture of the potential risks.
2. Prioritizing remediation efforts: Remediation efforts must start as soon as technical debt is identified. This can involve updating outdated technologies, refactoring code and improving development processes. Prioritizing these efforts based on their impact on the business can help manage costs and ensure that critical issues are addressed first.
3. Strategic planning for integration or separation: Developing a strategic plan for integrating the acquired company’s technology (or moving to a standalone model) is vital. This plan should include steps for addressing technical debt, such as standardizing processes, documenting code and ensuring compatibility with existing systems. A well-thought-out integration or separation plan can help mitigate risks and ensure a smoother transition.
4. Ongoing monitoring and management: Technical debt should not be viewed as a one-time issue but rather as an ongoing challenge that requires continuous monitoring and management. Implementing robust governance frameworks and regular audits can help keep technical debt in check and prevent it from accumulating to problematic levels.

Conclusion

Technical debt poses significant challenges in M&A transactions, affecting valuation, operational efficiency and integration/separation efforts. However, with comprehensive due diligence, prioritized remediation, strategic planning and ongoing management, these challenges can be effectively addressed. By proactively managing technical debt, companies can ensure smoother M&A transactions and realize the full potential of their acquisitions.

How A&M can help

The Alvarez & Marsal (A&M) Business Technology team brings business-driven approach to maximize your technology investment. Our team, which includes many experienced CIOs and technical experts, brings leadership and expertise to help turn strategy into execution and to overcome roadblocks to success.

A&M Business Technology can provide end-to-end technology M&A advisory services to private equity clients, their portfolio companies, as well as to corporate clients. Services cover the complete M&A portfolio from technical due diligence, carve-out and post-merger integration services, through to technology transformation, value creation (cost-out) and interim CIO support.

We work in all industries and sectors and help to maximize the benefits of M&A transactions, optimize technology, streamline processes, reduce costs and increase value creation.