Tech Enable your Q·of·E with a Q·of·T™: PART I
Today's Q·of·E: Trust but Verify, Verify, Verify
A Quality of Earnings “Q·of·E” study provides investors with validated evidence of a target’s financial health including both quantitative accounting and tax considerations as well as qualitative aspects such as customer/supplier concentration, product pricing, supply chain risks, key employees, etc. Spotlights are placed on key financial metrics such as EBITDA, FCF, NWC, capital expenditures, and taxes. All in the name of validating an estimated multiple (and associated valuation / price). While primarily crafted from historical performance data, the true purpose of the Q·of·E assessment is to gain insight into a target’s potential future performance and of course future value. This tool is widely embraced by the investment community to reduce information asymmetry on both the buy and sell side of deals. Complete and accurate knowledge by both parties is key to sellers garnering an optimal number of buyers, valuation stability during the due diligence process, and completing transactions quickly in today’s hyper-competitive, fast paced M&A environment.
But What About Technology?
Unfortunately, tech isn’t in focus for most mid-market Q·of·E studies and if evaluated during a comprehensive due diligence effort is typically assessed through pedestrian checklists or ad hoc / non-standardized deal team processes. Today's digital disruption is affecting every company in every industry and is impacting future value creation strategies like never before. Understanding what’s “under the hood” of a company’s tech ecosystem will significantly reduce deal risk and improve long term financial returns. And on the sell-side it can uncover or highlight innovative intellectual property that can improve valuation beyond simply EBITDA multiples. Unlike financial analysis, technology analysis is highly subjective. The explosion of software tools (languages, cloud services, platforms, etc), techniques, and strategies continues to provide endless ways to solve complex business problems. And with so many operational choices the risk of headwinds supporting a future value creation strategy is high. The typical tech landscape of mid-market firms:
Is often dotted with people, processes, or systems that are potential liabilities to an aggressive deal thesis. Bailing wire and duct tape may have enabled success to date but may not position the buyer well for future growth or market competition. New entrants unencumbered by legacy tech can be a real threat to your deal thesis being "Amazoned" prior to exit.
Contains hidden gems of digital creativity that could increase valuation beyond pure financials. Monetizing operational effectiveness or exposing add-on opportunities can rest on understanding where software and systems exist in the continuum of what's next. Knowing what intellectual property exists can significantly improve valuations.
Evaluating the operational technology of mid-market firms in the compressed timeline most Q·of·E studies demand is challenging, especially given the lack of standardization or industry guidelines.
What if there was a standard by which a target's technology could repeatably and accurately be evaluated?
What if there was a technology equivalent to the Q·of·E?
What if there was a Q·of·T?