For any existing enterprise, acquiring the appropriate digital asset as a part of an inorganic M&A will generally lead to increased growth, revenue and greater market share which can be expressed in clear quantitative metrics when driven by clear business case. New technology disrupts markets and generally require a fresh set of metrics to calculate the value that digital assets being considered for this acquisiion. Consequently, calculating M&A risk accurately in such instances is crucial to avoiding overpayment and losses down the road along with steps to focus on steps that will improve the odds of a successful M&A Transaction.

One primary consideration is to have well-thought-out value statements that consider not only what the target organization brings to the table on its own, but also the synergies that will be created by combining it into an existing ecosystem. When there is a strong understanding of value, diligence can focus on areas that inform forecast models and support the business case presented to the board. Integration activities then follow to allow value capture and potential success in the long term.

However, based on our experience with numerous M&A transaction helping with the “due dilgence” during the acquisition and post M&A Activities, it sometimes becomes clear to us when other considerations come into play, this M&A transaction will not result in a symbiotic relationship between the entities resulting in impairment or other financial reporting write-down in future reporting cycle(s). Hence, we have provided our thoughts on steps that would help to quantify value accurately leading to a successful M&A outcome:

1. Identify the true purpose of this proposed acquisition: Initially, identifying the true purpose of this acquisition is paramount to articulate and support the business case effectively. The objective of this step is to identify clearly what one hopes to achieve from this acquisition, and how it links to overall strategy and capital allocation policy. Sometimes, brand or product transformation objectives may trump cash flow metrics in the near term, and correctly understanding this may be critical in terms of overall strategy. Commercial due diligence and understanding the relevant market forces will drive due diligence efforts in the right direction to achieve the true purpose of this proposed acquisition.
2. Consider risk appropriately for an accurate valuation of this proposed acquisition: When the true purpose of this acquistion becomes clear, the next step is to appropriately consider risk by recognizing the differences from the buyer’s current business to this new digital asset. The current cost of capital is likely irrelevant but the buyer may not have the in-house capability to assess technology risk such as key talent flight risk, obsoloscence and competitive products being developed etc and use of third parties can help with identifying appropriate risks. Sometimes, buyers apply their internal hurdle rate to the cash flows of a much riskier business which can result in excessive valuation. After the appropriate risks are identified, one can apply the same valuation methods to these kinds of digital acquisitions and new/different value drivers can be considered when entering new and different markets. Identifying key performance indicators (KPIs) can be key and may include subscriptions, annual recurring revenue (ARR), customer lifetime value, etc with the data sensitized using a robust driver-based deal model.
3. Study how synergies may impact this M&A Transaction: Synergies are another value driver that need to considered differently in digital acquisitions – Cost Synergies may not be obvious and one needs to realistic about the ability to scale margins not be too optimistic. Additionally, Revenue Synergies may be unrelated to the buyer’s business, but the use of third parties to vet key assumptions can help with accurate valuation of cash flow and other financial metrics. Hence, in case of integration and cost assumptions, recognizing different cultures and organizational structures is important, as heavy integration and the desire for conformity can make this acquisition fail.

In our opinion, if aspirations are linked to long-term strategy and the right KPIs have been identified, challenged and sensitized, a clear picture of this M&A will become apparent. The Buyers can then make an informed decision to walk away from the proposed deal if the economics don’t make sense. However, a higher multiple can be justified, to make the case for this M&A Transaction to go forward, if Buyer is confident that all aspects of valuation including Model assumptions and risks have been appropriately vetted.