Calculating the cost of software risk exposure in M&A

Mary Roy, director at Creative Technology Management Solutions (CTMS), looks at M&A deals and the hidden costs of software licences associated with these transactions.

Mary Roy, director at Creative Technology Management Solutions (CTMS), looks at M&A deals and the hidden costs of software licences associated with these transactions.

Mary Roy, director at Creative Technology Management Solutions (CTMS), looks at M&A deals and the hidden costs of software licences associated with these transactions. Roy explains what pitfalls companies should look out for when considering M&A and how to avoid falling victim to unaccounted costs.

There is no doubt that British companies are on the acquisition trail, however, more often than not takeovers and mergers simply don’t live up to their forecasted potential. Recent research by Hay Group found three-quarters of mergers and acquisitions failed to live up to investor expectation. The survey of more than 300 business leaders revealed that only 9 percent considered their deal to have been completely successful in achieving its objectives, with a majority citing economic performance as the main obstacle.

So why isn’t M&A delivering the value and results expected? Successful acquisitions require attention to detail, planning and an understanding of all the expenditure, particularly the hidden costs that often fail to reach the asset register during negotiations and then subsequently have to be incorporated into the equation post-deal.

Speed is of the essence in any deal and the successful integration of ‘tangible’ assets, such as technology, financial systems and property portfolios, and ‘intangible’ assets, such as business culture, client relationships and leadership capability is essential. However, all too often companies fail at the first hurdle, which is to identify their asset landscape accurately.

Software assets commonly get overlooked and in many cases fail to appear on the asset register. This can lead to substantial post-takeover costs – for example often the total costs of software licences are more than hardware. This happens because companies understand how to value physical assets, such as people, buildings, fleet cars, IT hardware, but they often fail to understand the costs of software and software licences and the legal implications of not being compliant, such as civil action or even criminal prosecution.

As part of the legal requirements to sell or acquire a company the finance director or legal signatory must complete and sign off a document transferring the software used in the organisation, agreeing that it has been legally obtained and is accounted for.

Often companies don’t have accurate figures for the number of PCs within the business or how software on these PCs is licensed. For directors involved in acquiring or divesting a division or company – who will ultimately be responsible for signing a legal contract stating that the IT infrastructure is compliant – software risk is a problem that simply can’t be ignored.

Business risk exposure

Software licensing exposure can significantly reduce shareholder value, and we estimate that M&A costs can increase substantially if the level of risk is not accurately quantified at the beginning of the due diligence period. For example, if the correct paperwork is not completed or the appropriate licences not in place for a large company with 2,000 PCs, we calculate that the acquiring company could be walking into a risk of some £1.5 million.

As a case in point, when CTMS was recently asked to review an acquisition estimated to be worth $4 million (£1.9 million), more than $6 million (£2.9 million) of software licensing risk was uncovered – exposure that led to more than 20 days of lawyers’ fees to renegotiate the deal.

Most companies try to keep control of software licences, but owing to the ever-changing pace of IT and its growing complexities, it is hard to keep abreast of an organisation’s software estate. Think of the amount of upgrades to new or different versions a mid-sized company experiences, growth or shrinkage in the workforce and reflecting these changes to licence contract usage rights. These legal compliance issues just develop silently as hidden costs and don’t often reach the balance sheet or risk register.

Keeping an accurate tab on an organisation’s IT environment can be tricky – especially in organisations that are growing fast. In addition, the complexity of vendor licensing agreements, and a shortage of procurement specialists who have received in-depth software asset management training, usually means that software licensing exposure is an unfortunate rather than deliberate oversight.

Despite this, the harsh reality is that by failing to address the problem of licensing risk, CEOs and board-level directors are unnecessarily opening the door to hidden software costs that will inevitably resurface and hit the M&A bottom line hard.

Why software visibility matters

The Operational Research Society says that the lack of timely IT involvement in the M&A process can cost international companies millions of pounds every year. For buyers and sellers, the legal ramifications of software licensing risk are the same. Whether your organisation is involved in volume M&A agreements or strategic one-off deals, your level of software licensing risk matters and there is no substitute for achieving an accurate picture of the software licensing estate you are acquiring or divesting at an early stage in your negotiations.

Make a mistake and the cost of putting things right, both financially and in terms of re-building reputation, can be damaging in the extreme – particularly given the growth in accountability legislation, such as Sarbanes-Oxley 2002 and the Companies Act 2006.

Having an in-depth analysis of the IT assets that can be legally transferred at the point of sale is not as complicated as it sounds. Sophisticated IT and software asset management reporting tools are now available that can deliver fast, accurate results at fixed costs. The best ones will ensure that M&A due diligence is thorough and pain-free by providing:

  • A strategic management assessment of the current licensing position

  • An accurate report of the installed IT estate

  • An up-to-date baseline for ongoing software management.

In addition, in order to understand the immediate software installations and software exposure, companies can look at the licences themselves. The sort of information that is requested for perpetual licences in a licence transfer document from a software vendor includes:

  • Name and contact details of the customer and transferee

  • Product, version, language, initial country of usage, upgrade protection end date, number of licences.

The transferee acknowledges acceptance of the product’s applicable use rights, use and transfer restrictions and limitations of liability. These transfer documents form a legal obligation and companies and/or directors can be sued if facts are represented incorrectly.

Protecting against risk

Organisations need to rise to the challenge of understanding the legal and compliance issues surrounding acquired IT applications within the inherited infrastructure. In order to leave directors in a strong position when it comes to signing legal entity forms, they should know exactly what assets they have and that all information is correct.

To achieve this they must:

  • Look at duplication of applications/databases, unlicensed/over-licensed software, where licences can be re-harvested, where potential cost reductions can be made or potential cost savings on upgrade rights for software post merger/acquisition

  • Understand the cost and resources involved in integrating two IT infrastructures. IT migrations are increasingly seen as key to the success or failure of a deal, as much as 85 percent of transactions fail or do not meet expectations because of the inability to integrate inherited IT systems

  • Understand risk and cost of unlicensed/non-compliant software – companies need to review their IT compliance risk profile

  • Rationalise their IT infrastructure both pre- and post-merger and look closely at cost reduction and performance enhancement. Rationalisation can significantly reduce IT infrastructure and management costs.

At CTMS we have years of experience in dealing with these sorts of issues and as a result have developed a simple and pragmatic suite of solutions. Our fixed price M&A IT review service offers companies a cost-effective way to quickly understand their hardware and software profile, and is particularly beneficial to organisations involved in M&A or newly-merged businesses.

The concept of IT governance is likely to play an increasingly important role in shaping M&A best practice in the future. As senior level executives start to see the rapid performance improvements that a shared organisation-wide understanding of best practice business control can deliver, it’s likely that they’ll also start assessing an organisation’s share value against its ability to deliver full visibility of its software and hardware assets.

For company directors that can see M&A activity on the horizon, biting the software risk bullet is an essential next step.

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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