Decision making
in complex and volatile times

Business models are evolving fast in the digital era, which means the ways that companies identify digital value and risk must develop too. How can investors and business owners assess their digital assets and unlock the growth that is there for the taking?*

Organisations’ enforced flight to digital during the global pandemic has driven home the centrality of digital technologies to businesses and economies. By 2022, nearly two-thirds (65%) of global GDP will derive from digital technology and platforms, according to research firm IDC.1 The World Economic Forum, meanwhile, estimates that 70% of new value created in the global economy over the next decade will be based on digitally enabled business models.2

So investors need to be able to evaluate the digital assets and capabilities of the companies they oversee and of the M&A targets they have in their sights. “Digital value assessments are likely to change how deals are executed,” says Ian McCaw, Head of Digital M&A at Aon. “As digital underpins more business models, deal transactions can no longer rest on financial analysis alone.”

Business owners must also be able to conduct such assessments, according to Stewart Licudi, Managing Director of investment bank William Blair. “Things move very quickly,” he says. “And if you believe that the quality of your technology and digital strategy means you are a superior business, you definitely want to articulate that as part of your story.”

Here, we provide three ways to assess digital value in businesses, alongside the unique perspectives of the key stakeholders in most deal transactions: a strategic investor, a business owner and an investment banker.

1. Quantify digital performance

When a company seeks funding, assertions of its digital capabilities are typically part of the pitch, whether it is a tech start-up or a decades-old incumbent. Investors and lenders need to assess whether the company’s digital platforms and performance stack up to the management’s assertions. That process should involve a forensic examination of the company’s digital datasets to see how its platforms perform.

Depending on the type of business, the key performance indicators (KPIs) that investors and lenders evaluate could relate to online usage – volume and growth of active users, click-throughs and downloads, for instance. And they need to ask questions about the extent of fraudulent traffic and its impact on the KPIs.

A thorough digital review should also consider the scalability and resiliency of the platform’s underlying technology, says Mr Licudi. “If you're saying that you serve a million clients now and will serve 10 million in three years, a buyer wants to understand how your technology can support 10 million,” he says. “If it can’t, it will require more investment. But the buyer’s experts may conversely think you can in fact scale it to 20 million. It all has a direct impact on a transaction.”

Assessments of scalability may take in the number and state of the company’s servers, the extent to which its platform runs in the cloud or on-premises, and its reliance on legacy technologies. Some investors focus on the type of software the target company uses. “For us, for example, a company’s use of open-source solutions could be an indicator of a more modern and scalable set-up,” says Andreas Thors, who is Senior Lead Operator at global private markets firm Partners Group.

Mr Thors says it is also necessary to take a close look at the target’s technology team. “It’s important for us to understand the rate of turnover in the team,” he says. “Tech specialists, and especially good developers, are so hard to come by today. We need to know if the company can retain them.”

2. Value the intangibles

Much of what creates digital value in businesses is intangible, taking the form of intellectual property (IP). This may be the data that a company collects and the insights it systematically draws from it. It may be the source code underlying a company’s online platform, or the algorithms it has created to build unique machine learning capabilities. These are digital assets, and they can be assigned a monetary value in the same way that plant, property and equipment can.

ATPI, a corporate travel services provider, is currently evaluating its digital assets. “If you’ve built a digital platform that is both a competitive differentiator and may be a revenue-generator in its own right, it makes sense to put a value on that,” says Ian Sinderson, ATPI’s Chief Executive Officer.

Mr Sinderson sees potential to use this kind of valuation to secure loans or venture capital funding – especially if the intangible collateral is insured. As Will Kier, Head of IP Risk and Insurance at Aon, says, “With the asset mix of the global economy shifting towards intangible, the insurance market has realised it can play a valuable role in unlocking the value of these assets”. Insurance-enabled IP-backed lending is now a genuine alternative for high-growth companies seeking to raise capital without diluting their equity stake.

Quantifying the value of a company’s IP strengthens its position in front of potential buyers, says Mr Kier, but it can also help secure other financial advantages. In ATPI’s case, says Mr Sinderson, that tactic also has strategic merit if valuing the digital assets leads the technology team to go out and generate new revenue streams for the business.

3. Balance risk and opportunity

Few strategic investors would consider taking a stake in a business without assurance about the integrity of the target’s cyber defences. Buyers are increasingly doing intensive cybersecurity evaluations of their targets to make sure they can safely integrate them into their own core business.

That kind of digital risk assessment often involves engaging third-party experts to detect system vulnerabilities – through penetration testing, for example; conduct dark-web scans to see if company data has been exposed; and assess the quality and integrity of the company’s source code. But a risk assessment should extend beyond cybersecurity. How does the target company collect data, and where does it store it? Are its data practices robust and compliant with ever-tightening data privacy regulations?

“We conduct such outside-in assessments to see if there are skeletons that we – and the business – should worry about,” says Mr Thors. “Finding them doesn’t necessarily mean that their management is trying to hide something. Sometimes they just don’t know about the problems, and our due diligence leads to action to address them.”

Assessments of digital risk must also consider the human element. Does the business have the right skills in place to manage major technology initiatives? “Technology upgrades or cloud migration, for example, as desirable as they are, can end up being very costly if your team lacks the experience of managing them”, says Mr Sinderson.

A discipline matures

Forensic digital reviews are not yet a standard part of M&A due diligence, but that is likely to change as digital accounts for an ever greater share of businesses’ value.

“Digital and IT are already a large cost item for almost every business, given the amounts currently being invested in it,” says Mr Thors, and he believes scrutiny of those assets and their performance and quality will come to hold nearly as much importance as that of a company’s financials.

The discipline of digital assessment is also rapidly maturing. In the investment industry, the sophistication of such reviews has advanced by leaps and bounds in the past three years. This particularly applies to the evaluation of back-end digital infrastructure and applications, according to Mr Thors. The next challenge, he says, is to improve even further the front end that interacts with clients and generates revenue: “A step change will come when we are able not just to identify companies’ digital strengths and weaknesses but to identify paths for business growth.”

* This article was written by Longitude, a Financial Times company, in partnership with Aon.

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