#1: Purchase Price Allocation (PPA)

Whenever an IT company acquires another IT company, the first step is to allocate the purchase price to all the assets of the latter. Each target IT company has assets in multiple forms. These assets could be tangible items like servers or other hardware. The assets can also be software licenses, patents, and goodwill. It’s critical to allocate acquisition cost to the Fair Market Value or FMV of these assets.

But the process is complex. It’s difficult to value some non-tangible assets like software and intellectual property. Now, the problem is that the majority of such IT companies have assets in non-tangible forms. If these assets are overvalued, it might push the target company’s goodwill..

#2: Impact on Financial Statements

Whenever an IT company acquires a target company, every financial metric of the previous one changes entirely. For example, its EPS (earning per share), depreciation, and amortization changes right away. Let’s say your IT company is acquiring another company. Now, you will acquire its assets like software and hardware, too. But this will alter your depreciation cost. In this particular case, your depreciation might go u. Result? Your bottom line changes.

So, it’s critical for IT firms to consult merger and acquisition experts like CROWNGLOBE. These experts can help determine whether the asset is accretive or dilutive. Reason? Well, if the acquisition is accretive, the buyer’s EPS rises. On the contrary, if the acquisition is dilutive, the buyer’s EPS drops.

Almost every IT company acquires a firm that has immense growth potential. But such acquisition might cause short-term EPS dilution because of integration cost. At CROWNGLOBE, our experts offer accurate financial modelling and forecasting to help our clients pre-determine impacts of such M&As.

#3: Tax Considerations

This is the biggest headache for any IT firm dealing with M&A. Acquirers have two options to pick from for a deal’s structure. The deal can either be structured as an asset sale or a stock sale.

Let’s say the acquirer chooses the deal to be an asset sale. In such a case, the buyer gets a chance to step up the tax basis of the acquired assets to their FMV. Benefit? Well, this will help them increase their depreciation deductions. And higher the depreciation deductions the lower the future tax liabilities.  

But what if the acquirers decide to treat the deal as a stock sale? Well, this changes everything. Now, the gains here are taxed at lower capital gain rates. But the most important part? The assets return their historical tax basis.

On top of that, IT companies can benefit if they elect Section 338(h)(10). This option allows a stock sale to be treated as an asset sale for tax purposes. Result? The buyer gets the benefit of the stepped-up tax basis, and the seller retains the benefits of the stock sale.  

So what could be the ideal choice? Well, there is none! Each merger and acquisition is unique. It’s better to consult with an IT M&A expert to choose the right option.

#4: Handling Goodwill and Intangibles

Goodwill and intangible assets are central to IT M&A transactions. In most cases, the value of an IT firm lies not in physical assets but in intellectual property, customer contracts, and goodwill. Accurately valuing these intangibles during an acquisition is crucial to ensure the transaction is financially sound.

Goodwill is tested annually for impairment. IT firms, especially those reliant on recurring revenue from subscription models or cloud services, need to carefully assess how the acquisition will impact long-term profitability. Any reduction in expected future cash flows could result in a goodwill impairment, negatively affecting the acquirer’s financial statements.

#5: Synergies and Integration Costs

Achieving synergies is a primary goal in most M&A transactions, but in IT, integration costs can be high. Combining two IT infrastructures, harmonizing software platforms, and merging customer data are complex tasks that can take longer than anticipated. Any delay in achieving synergies can diminish the overall value of the deal.

Integration costs, including upgrading IT systems, retraining employees, and merging cybersecurity protocols, must be carefully accounted for. IT companies should develop a clear post-merger integration plan outlining specific milestones for achieving synergies. Failure to do so can lead to prolonged disruption, increased costs, and reduced profitability.

#6: Regulatory and Compliance Considerations

IT firms must also consider the regulatory environment during an M&A. Data privacy laws, intellectual property protections, and industry-specific regulations can vary significantly. For example, companies dealing with sensitive customer data may be subject to strict compliance requirements under laws like the General Data Protection Regulation (GDPR) or the California Consumer Privacy Act (CCPA).

During the due diligence phase, acquirers must evaluate the target’s compliance with these regulations. Failure to comply can lead to significant penalties, tarnishing the buyer’s reputation and financial stability. For US IT firms with international operations, understanding the global regulatory landscape is key to minimizing post-merger risks.

#7: Cybersecurity and IT Risk Management

In the IT sector, cybersecurity risks are paramount during M&A transactions. Acquiring a company also means inheriting its cybersecurity vulnerabilities. IT firms must conduct thorough cybersecurity due diligence, assessing the target’s existing security protocols, past breaches, and current risk management strategies.

A breach during or after the acquisition could severely damage both companies’ reputations and financial positions. Ensuring that the target company has robust cybersecurity measures in place and aligning them with the acquirer’s security policies is essential to mitigating this risk.

Additionally, IT infrastructure compatibility is a common issue in M&A transactions. Merging disparate systems can be time-consuming and costly. Without proper planning, integration delays can erode the expected value of the deal.

#8: Employee Retention and Cultural Integration

In any M&A transaction, retaining key employees is crucial to maintaining business continuity. This is especially true in the IT sector, where talent is often the most valuable asset. Acquiring companies must identify key personnel early in the process and develop retention plans to ensure they remain post-acquisition.

Cultural integration is another challenge. IT firms often have distinct work cultures, and aligning them post-merger can be difficult. Misalignment in management styles, work processes, or company values can lead to employee turnover, diminishing the value of the acquisition.