Navigating Pitfalls in Financial Institution Acquisitions

However, where companies fall short in their post-acquisition growth expectations is proceeding with the investment transaction without examining the potential risks and challenges. These include thoroughly analyzing topics like fit of strategy, operating model, and culture as well as the actual value of assets for the acquiring organization. Even if some barriers can be overcome through a well-managed integration process, the more fundamental mistakes become costly and difficult to handle if red flags are not initially identified and dealt with. Therefore, undertaking a thorough Tech Due Diligence (DD) is indispensable to maximize business impact and avoid potential complications during a tech acquisition process, especially as it helps lay the foundation for a successful acquisition or post-merger integration (PMI).

Tech DD refers to an in-depth technical analysis of a target asset (a company as a whole or a digital platform) considered for a merger or acquisition. It involves gathering, processing, and using data to identify risks, highlight potential red flags, and discover and assess merger prospects. These insights are typically contextualized from the target company’s business model, tech architecture, and capabilities. A Tech DD is useful for evaluating costs, operating models, and organization and value creation levers, which allow buy-side stakeholders to make informed merger or acquisition decisions.

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Why is conducting a robust Tech DD necessary?

A thorough and robust Tech DD allows acquirers to understand the value of their investment, evaluate existing tech structures, and identify opportunities for business growth from the acquisition and potential risks.

The process enables decision-makers to understand the target company’s technical value and accurately represent the acquisition’s short- and long-term worth.

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Conducting a Tech DD helps:

• Augment a business-oriented analysis of tech assets to guide well-rounded business decisions.
• Eliminate possibilities of negative ramifications in the form of future risks, setbacks, or financial losses that could potentially result from overlooking red flags. Red flags may include issues with licensing, software or hardware incompatibility, loss of specialized knowledge, etc.
• Brace for significant changes that may arise as a natural consequence of the merger or acquisition, e.g., adaptations to tech operating and collaboration model.
• Confirm the investment/acquisition thesis and identify tech-enabled value levers.

Thus, it becomes prudent for buy-side investors to undertake a thorough understanding of the target company before acquiring its technology stack, processes, tools, and human resources.

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What happens when companies proceed without conducting a proper Tech DD?

Examining 4 Major Pitfalls.

Executing successful merger and acquisition transactions requires a robust Tech DD to avoid several setbacks. At BCG Platinion, we have vast experience with running thorough Tech DD’s at several financial institutions. Illustrated along one of our case experiences, we assembled an overview of the most common pitfalls that buy-side vendors often face:

Pitfall 1: Mismatch between acquired tech capabilities and business strategy.

Misalignments in business goals during tech mergers and acquisitions are not unheard of. They can result in complexities, especially if the target company’s tech landscape needs to be aligned with the buy-side’s business strategy. Understanding how well the acquired tech capabilities can be absorbed post merger or acquisition may take time, especially before executing a deal. For instance, a target company may demonstrate focused core systems that fit a business’ current strategies; however, significant functional gaps may become evident over time, eventually underscoring the deal’s failure. Consider the case example of a leading European retail bank with an extensive branch network. The bank operates with limited tech capabilities and depends on an external vendor. Their tech architecture is complex, much like their legacy organizational structure, in which they must satisfy multiple stakeholders. They seek to acquire another entity with requisite technical capabilities, with the objective of expanding their online business and reducing dependence on external vendors. Thus, they finalize an acquisition deal based on the target’s core systems that, on preliminary observations, align well with the bank’s current technical needs. Only upon executing this deal does the bank then realize that the target entity’s slim and focused tech core landscape is sufficient to only serve the bank’s legacy-driven demands. In such a case, post-acquisition expansion of the bank’s core system results in significantly higher effort and resources than initially outlined prior to deal signing. This is where conducting a timely and thorough tech DD of the target company’s capabilities would have helped. It would serve the bank’s required models’ post-acquisition and lead to a successful investment.

Pitfall 2: Unmet expectations, incompatible tech stacks, and architectures.

Sometimes, buy-side organizations rely on superficial observations to execute technology-driven merger acquisition decisions. While they may gather feedback, the findings, or analysis of findings, may be insufficient. Their positive findings may not apply in entirety to their unique business use case and needs and create concerns. For instance, despite having a suitable set of features, the target company, after acquisition, may need to be more suitable with a need to adapt significantly to their technical and organizational integration needs of chosen. A merger in this case may lead to failures arising from issues like incompatible application landscape, complexity of architecture, missing integration, or insufficient documentation. Other problems that could also crop up include a lack of broad integrability, expensive upgrades, or incompatibility with the buy side’s core system. There may also be possible impact on future readiness such as limited scalability, lack of capabilities, slow time to market for new features and so on. Taking the same case example of the bank from above, post-acquisition or merger, there may be indication of the buy-side realizing that they financially and regulatorily underestimated the limitations of their existing monolithic architecture. Ensuring further scalability demands modularization, requiring extensive effort and resource investment over the next 2-3 years. Moreover, there may also be gaps in fulfilling regulatory requirements and integrating with the different buy-side alternatives. This is something that would have been avoided with a thorough Tech DD at the right time.

Pitfall 3: Mismatch in operating models, organizational incompatibility, and overstretching.

Uncover the complexities traditional companies encounter in acquiring agile, modern firms, emphasizing the critical role of comprehensive tech due diligence in preventing operational and budgetary conflicts in these mergers. Larger and more established companies are usually not accustomed to major shifts and diversity in their management and operation models as compared to new-age entities. Therefore, leaders at legacy organizations often prefer to undertake acquisitions to benefit from radical and diverse operational models of newer companies, including their tech stack, tech delivery, and culture. However, in this process, traditional organizations may overlook critical aspects of the sell side’s delivery organization simply because they are excited to proceed with the advantages the merger or acquisition accorded to them. Eventually, such deals may result in incompatibility in capabilities and experience, giving rise to new problems in the resultant entity.

Taking the case example of a legacy organization looking to acquire a new-age company, with agile and backlog-oriented approaches. The buy-side has a less flexible approach to managing the potentially acquired entity. On the other, the target company could benefit from understanding the buy-side’s well-established structures and processes. In such a scenario, ensuring robust and timely tech DD can empower both entities to be equipped with the knowledge to synthesize an efficient and agile working method. A properly conducted Tech DD can highlight if and how the two entities can work well together, minimize organizational incompatibility and prevent budgetary overstretches.

Pitfall 4: Insufficient analysis of alternative options.

Another reason digital transformation initiatives fail is the buy side’s myopic outlook, leading to executing deals based on short-term opportunities and insufficient analysis. Many companies discover shortcomings and risks only after initiating the deal, leading to excessive costs and resource use. This can be avoided if companies evaluate market alternatives in the form of different business and operation models that may suit them more favorably. In our case example, the objectives intended to be met through the acquisition could have been equally fulfilled by choosing a different target or by obtaining the required capabilities through means other than the acquisition e.g., sourcing needed capabilities. Nonetheless, a thorough assessment and exploration of other possible courses of action were not conducted. This led to a limited decision-making scope, resulting in a less advantageous binary choice of either proceeding with the acquisition or not. Mitigating merger and acquisition pitfalls – 8 essential considerations to result in successful tech-driven mergers.

Conducting a robust Tech DD allows buy-side vendors to make accurate and relevant merger or acquisition decisions that spell success.

In that vein, below are some critical considerations to consider when conducting Tech DD.

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Consideration 1: Ensuring early transparency about requirements on the acquired target platform.

Research suggests that over 70% of tech-driven mergers and acquisitions fail because digital transformation goals are not explicitly laid down – one of the biggest reasons technical requirements should be spelt out during the Tech DD process. This includes evaluating whether the target platform will fill technical and functional gaps or if employees will be equipped to use digital platforms after the resulting entity is in place.

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Consideration 2: Considering buy-side adaptations to the business model.

Although buyers often evaluate the target platform’s technical specifications and consider changes before executing a deal, sometimes, adjustment needs may arise. This may imply significant modification of buy-side business models and procedures. Clarifying these adaptation requirements during the tech due diligence analysis can allow companies to undertake specific changes and adaptations before the deal, leading to time and cost efficiencies, or refrain from the deal.

Consideration 3: Conducting tech deep dives to ensure future readiness and architecture fit.

PMI KPIs take a beating if the buy side fails to consider evolving technological requirements. Thus, the buy side must consider the dynamic business landscape when conducting a Tech DD. Merely following a static list of goals can result in several pain points. Performing a technical deep dive allows the resulting entity to ensure an appropriate future-ready, scalable architecture that can evolve with time.

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Consideration 4: Ensuring clarity on integration requirements and the acquired platform’s ability to evolve accordingly.

A target platform may only serve the purpose post-acquisition or merger if it supports crucial integrations. Hence, conducting a Tech DD that clarifies the expected features and behaviors of integrations is vital. Disclosing integration requirements and objectively understanding the ability of the acquired platform to evolve and integrate helps set expectations, and timelines for integrations. This ensures access to a successful and functioning integration strategy.

Consideration 5: Assessing the organization’s maturity and its compatibility with the buy side.

Organizational maturity is when the buy side understands the quality of the sell side’s internal structure and processes. This is yet another critical consideration before deal execution and to include during a Tech DD. It is relevant to become aware of a target company’s potentially differing maturity level in its organizational capabilities. Therefore, applying an understanding of organizational maturity models can prove to be advantageous. This includes but isn’t limited to the data maturity model, or maturity models for site reliability engineering (SRE).

Consideration 6: Early planning of PMI and preparation of organizational structures post-merger.

Studies show that deep project planning allows for post-merger success and growth. There is a strong correlation between project planning and success. However, such deals require a deep dive into data and insights to understand expectations and goals appropriately. Conducting a detailed preparatory Tech DD allows companies to unmask hurdles. It also helps prepare for challenges that could unravel in terms of shifts in the organizational structure post-deal execution.

Consideration 7: Clearly defining strategic targets and considering all options holistically before proceeding.

Strategic planning helps businesses create an achievable and purposeful plan and can be the make or break for a merger or acquisition deal. Effective strategic plans are particularly important in tech-driven acquisitions and mergers, where visualizing pathways clearly before executing the deal is essential for the business to thrive eventually. Since there may be multiple ways to do so, undertaking a proper Tech DD analysis helps companies identify the different risks, needs, and remedies. This allows defining strategic targets and preparing for future changes clearly.

Consideration 8: Conducting a forward-looking analysis of risks and opportunities, with a complete overview of the market condition.

Although tech due diligence focuses on the technical aspects, it also helps consider and evaluate market-oriented factors more holistically. The rapid evolution of technology today has made it ever more critical for companies to consider how market dynamics can create risks and opportunities during or after executing an acquisition or merger deal. Thus, the technical aspects of such risks and opportunities must be highlighted via a Tech DD since platforms often evolve quickly.

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