Authored By Dr. Jack G. Nestell with contribution from John M. Bielecki
Why do Private Equity Firms Invest in Portfolio Companies?
In order to understand the significant value of proper IT and ERP due diligence, it helps to understand the primary objectives of private equity. A high-level definition of private equity would be: to build healthy and vibrant organizations with organizational cultures oriented towards teamwork, organizational learning, innovation, and creativity while providing customers with exceptional value through quality products and service. This definition is quite consistent among most PE firms. In order to accomplish this objective, it requires great people, efficient and effective processes, and appropriate technology. Sure, private equity firms invest in organizations (their portfolio companies) in an effort to improve the top and bottom lines. But, we are certain that all PE firms will tell you that this positive and sustained desired financial performance outcome only occurs when organizational culture is developed and supported by people, processes, and technology that is well-aligned in mission, vision, and value. It is true that some acquisitions struggle, or even fail, as some PE firms invest in highly distressed organizations hoping to improve organizational performance and to turn the organization around. But the goal remains the same: to develop a purpose-driven culture adequately supported by effective and efficient processes. This goal requires that IT and ERP be aligned with the organization.
IT and ERP Driven Business Intelligence: A significant Competitive Advantage
Second, to an organization’s people, there is nothing more important than data. Reliable and immediate access to accurate data become information that becomes business intelligence. That is Accurate Data + Timely Data = Good Reporting. Good reporting leads to sound Business Intelligence. And therefore, trusted Business Intelligence creates a high confidence level in strategic business decisions and management. Business Intelligence is a significant influence that allows companies to react appropriately to ever-changing market conditions. Moreover, sound business intelligence is a significant competitive business advantage in a competitive global market. This is precisely why pre-acquisition IT and ERP due diligence is so crucial. The primary intent of a successful IT and ERP due diligence is to provide Private Equity firms and their investors’ confidence in that their portfolio can provide reliable and trusted business intelligence without incurring or creating and significant business risks. And, if current state IT and/or ERP does not provide the proper business intelligence, then any investment required to address significant gaps requires an accurate and professional assessment as to the time, costs, and effort required to address any significant business intelligence gaps.
IT and ERP Due Diligence Objective
The primary objective of an IT and ERP due diligence should be to review the current state ERP solutions and the Information Technology (IT) department’s operations to inform the PE firm on the effectiveness and gaps. The due diligence needs to include a thorough assessment of IT infrastructure, IT process, IT team, and ERP alignment with the organization and business requirements. The assessment should also consider IT’s ability to support organizational growth and include recommendations for IT and ERP continuous improvement opportunities. A primary objective is to also understand current ERP and Information Technology ownership and process. IT due diligence should examine key areas such as IT stability, IT security, IT performance, IT support process, regulatory and organizational compliance, budget requirements, and appropriate level of IT resources. The critical objective is to confirm that no significant IT and/or ERP risks or major IT and/or ERP financial exposures exist that could substantially impact on-going business operations. This due diligence process should also examine risks that should be considered as a part of the pre-transaction agreement language.
The due diligence goal is to provide vendor-neutral, unbiased, and objective information to contribute to an informed investment decision and eliminate acquisition risks. In general, the due diligence is intended to highlight key points that should be considered from a private equity investment perspective in an effort to increase the likelihood of IT/ERP success and reduce investment risk. Ultimately, the goal is to provide an examination that contributes to protecting and ensuring the investment.
IT and ERP Due Diligence Approach
The approach should be one that effectively provides accurate gap and risk analysis determines if any significant operational risks exist due to IT and/or ERP, and then provide sound options for addressing gaps and risks. Several documents should be requested and reviewed, conduct portfolio employee interviews with appropriate personnel, and then complete follow up calls and analyses. The approach should maintain a neutral, unbiased, non-political, and objective interview process followed by cross-referencing interview feedback against provided documentation. The IT and ERP due diligence must maintain a structured and deliberate methodology that ensures adequate and appropriate due diligence of the three main components of any organizational IT department: team, process, technology, and its infrastructure. In addition, the ERP and IT due diligence must focus on a holistic view of ensuring the alignment of ERP and IT operations and its support of the business operations.
The IT and ERP due diligence is best provided by a vendor-neutral third party. Else, you get into deliberate and undeliberate biases impacting your due diligence. Moreover, you want objective facts and recommended solutions, not opportunities for product sales events from vendors or their value-added partners. Opportunities for any needed product sales events comes later if/as needed through proper product review and being “smart consumers”.
Remember to use care and being professional and proper in your approach. During the process, it is about listening, observing, and examining. While on-site during the observation process, for instance, it is not necessary to provide your opinion or to criticize in any way. Moreover, if due diligence results are shared with the portfolio in an effort to address issues pre-or post-acquisition, it has to be shared and discussed in a way that is proper and professional. On occasion, an internal IT or ERP implementation team member may want to provide a “rebuttal” to any productive and professional observations in the formal report. This is fine. Not all employees will heed the feedback especially if the due diligence is providing constructive suggestions within their area of responsibility. Although sharing one’s experience requires some subjectivity, as best as possible, maintain an objective, vendor-neutral, and “call it as you see it” approach. After all, that is why the Private Equity firm is paying you. Your job in providing due diligence is to provide objective feedback as possible based on years of experience and expertise. Even if others have different perspectives, opinions, and perceptions, a sound approach to due diligence provides investment and organizational benefit.
Summary of The General Process
- Make sure you clearly understand the business and PE goals prior to beginning the assessment.
Ask the right questions at the onset. These questions will help guide IT and ERP due diligence. When it comes to providing final recommendations and IT and ERP strategy roadmap, these strategic suggestions need to be aligned with organizational goals. The objective is to ensure proper support for potential investment objectives and goals.
- Request appropriate IT and ERP documentation and information.
There is a vast amount of documentation in terms of IT team/resources, IT infrastructure (networks, systems, applications), IT procedures, and ERP related documents that must be thoroughly reviewed. (More to come on specific documentation in upcoming posts).
- Conduct Operational tour
The IT and/or ERP due diligence results need to be informed by cross-referencing provided documentation, team member interviews, and evidence confirmation with what is visually observed during an operational tour. Cross-checking multiple sources allows for confidence in ownership and process evidence. What you see may not always be consistent with what you hear.
- Conduct interviews
The IT and/or ERP due diligence results need to be informed by cross-referencing provided documentation, observation, and direct evidence confirmation with what you hear during interviews. Cross-checking multiple sources allows for confidence in ownership and process evidence. What you hear may not always be consistent with what you see.
- Assess appropriate IT and ERP documentation and information
- Review the IT/ERP team, processes, and infrastructure to ensure alignment with organizational strategy. The point is to assess if IT and ERP properly support business operations.
- Assess the strategy and alignment of all IT components (IT team, process, and infrastructure) to current and future business needs.
- IT infrastructure: Security, server room, data center, network (voice and data), hardware, fault tolerance and redundancy, backup and restore, performance availability, change management, end-user support, storage systems, and application review. Are the solutions themselves adequate?
- IT Team: Assess any resource needs or constraints
- IT Process: Thorough review of IT practice and operating procedures.
- Clearly examine and consider holistically the observations, interviews, and data.
Did any pre-acquisition considerations, concerns, or risks emerge? Utilize effective qualitative research techniques in order to reach an objective, vendor-neutral, and non-bias report. Utilize evidence such as appropriate interview data, observations of business process and documentation, and direct verification and validation.
- Provide a formal report
The formal report should include an executive summary, the scope of work, approach and methodology, further details and observations that support the due diligence results, and a list of recommendations.
The Objective of the Final Report:
The goal with the final report is to provide the PE executive team with clear, well-articled, and objective discoveries of immediate business operational concerns that could impact the business upon acquisition. The report should also identify the less critical but urgent items that should be addressed upon acquisition. While every organization has its IT and ERP “flat spots”, the goal is not to focus on regularly and fairly routine IT operational improvement opportunities. Rather, describe issues that may have a significant impact on business and investment risks that may create significant time, financial, effort, or even legal risks post-transaction.
The Report Should Include:
- The current State of ERP and IT Summary
- Executive Summary: High-level review with a focus on immediate potential investment risks as it relates to IT and/or ERP.
- Advise of any language that needs to be included in the sale agreement or a Transition Services Agreement (TSA).
- Identify immediate ERP/IT risks that may have an immediate impact on potential acquisition
- Clearly document IT/ERP gaps that are not acquisition impactful but have a significant impact on operational efficiencies.
- The executive summary needs to be clear on any identified budget or financial implications.
- Visual Scorecard Indicating High-Level Status of Current ERP and IT Components/functions.
- Review of IT Due Diligence Scope of Work
- Review of Primary Objective of Due Diligence
- Description of Approach
- Provide an appropriate level of detail and observation evidence needed to support the executive summary.
- IT/ERP Infrastructure review: Is the solution appropriate for today and future growth
- IT/ERP Process and SOP concern: Is the actual technical IT solution properly managed. Is the ERP properly aligned with the business processes and requirements
- IT/ERP Organizational concerns: Any resource gaps or constraints in terms of personal to manage and support IT and ERP systems.
- Recommendations: Provide any immediate, mid-term, and long terms options required to address any team, process, or technology gaps. Include time and cost guidelines. Provide suggested recommended actions to be considered immediately upon post-acquisition. These are the areas believed to have the biggest impact on improving performance and minimizing risks. Recommendations also need to include any potential considerations or language for the pre-transaction agreement.
Private Equity and Portfolio Benefit
The organizational benefit of proper IT and ERP due diligence for private equity firms is objective, vendor-neutral, third-party, and unbiased review of the portfolio that the firm is considering as a potential investment. As a third-party due diligence provider, it is critical to leverage your professional experience, subject matter expertise, and then “call it as you see it” using an objective as a possible approach. The due diligence is intended to provide and offer insight to help ensure that the post-acquisition process is as smooth and productive as possible. The goal is to provide sound feedback and recommendations to minimize short and long-term acquisition risk. If the due diligence is done well and thoroughly, the portfolio will benefit from reflection of the feedback, insight, and/or executing the recommendations.
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