Introduction – High requirements due to digitalisation
In view of the digital transformation, companies have to adapt ever faster and, sometimes, even suddenly to the changing needs of their customers and to market conditions. Here, companies can initiate such a transformation process either by means of internal processes or by purchasing the requisite knowledge via specific acquisitions of technology-based start-up companies. In practice, most companies prefer the latter method. This means that there will be a massive change in the requirements placed on the M&A process. IT due diligence as well as financial due diligence, in particular, will be especially highly relevant here because the valuation of disruptive business plans and start-up companies is associated with major uncertainties as regards the future performance.
Disruptive technologies considerably affect earlier value chains and established business models. In the last few years, internet-based service companies have established themselves here, in particular, and online retailing has taken large market shares from bricks-and-mortar retailing. Likewise, in the producing sector a great number of opportunities are arising for enhanced competitiveness through digitalisation. Processing very large quantities of data, in particular, and implementing artificial intelligence play significant key roles here. In order to be able to participate in the transition process of a digital transformation, early on, established companies are thus increasingly acquiring shares in digital technology-based start-up companies.
The basic problem
An essential component of the M&A process is the carrying out of due diligence. In this phase, an analysis is made of the historic development of the tax, legal, personnel and financial risks of the target business in order to ascertain whether or not this business meets the expectations and requirements of the potential buyer. In the course of this, the implications of the digital transformation for the M&A process and the need for adjustments associated with these will become particularly obvious since start-up companies as well as disruptive business models generally do not produce long-term information about the company. Up to now, this has precisely constituted the essential basis for carrying out due diligence successfully.
Financial due diligence
For due diligence based on financials, a forecast of future earnings is made using historic data, or alternatively a plausibility check is performed on a financial plan, as a result of which it is then possible to provide an overview of the financial situation of the business under review. For start-up companies and disruptive business models however such forecasts are possible only to a very limited extent. In the planning and start-up phase, these companies and business models are primarily characterised by high levels of investment and rising capital requirements for innovative products and services. It is frequently difficult to make any inferences as to the future performance on the basis of the company history to-date because it is highly likely that, in the future, there will not be a repeat of these phases and the financial results associated with them. Then again, factors such as a benchmark and market data analysis are of key importance for the valuation and the forecast.
IT due diligence
The aim of IT due diligence is to ascertain the integration capability of the entire IT environment of a potential target business. The greater the divergence here between the IT environments of two companies, the higher the costs associated with the process of integrating them will be. Here, such costs will depend, for the most part, on the compatibility or the adaptability of the various goods management/ERP systems. Other components of the analyses that take place as part of IT due diligence include recording and evaluating the existing hardware and software systems, the IT processes as well as the current projects. Moreover, the subject of data protection has gained considerably in importance, at the very latest, with the introduction of the EU General Data Protection Regulation. However, it is not only the security of personal data processing that is crucial but also the external security of company-related data, such as, for example, protection against cyber attacks.
Selecting the right valuation method constitutes another key component in the M&A process. When making this choice for start-up companies, the very early phase in the business cycle will be particularly relevant. During the orientation and planning phases, as well as the setting up phase, qualitative valuation methods are more likely to be applied because, during those stages, the historic financial figures will not be particularly meaningful. Such methods include, for example, an analysis of the market potential and the innovation capability of the products. By contrast, in later business cycles, the valuation is likely to be based on income-oriented methods. When valuing a start-up company it generally makes sense to analyse the weighted average of the results of several valuation methods. In the course of this, the following valuation methods should be included when carrying out such an analysis: the benchmark method, venture capital method and DCF terminal value method.
Outlook: If companies have not yet made any adjustments to their business processes to take account of digitalisation then we would urgently recommend that you rectify this soon. In this case, adjustments can be achieved, firstly, by specifically recruiting qualified expert personnel, or then again by entering into cooperation with digitally oriented start-up companies. Moreover, calling in external consultants lends itself to initiating the switch in internal processes to ones that are digitalised.