Due Diligence: Dealing with Price Adjustments for Digital Debt

Digital debt is a phrase that we are hearing more and more regularly, especially in the space of technology due diligence. The world has changed. To stay relevant most of the leading companies in the world rely heavily on technology and data for their operations.

Companies like Tesla, Uber and Revolut are often discussed as examples of “digital disruptors” — agile, transformative upstarts that have utilised technology to create revolutionary new services that consumers are finding irresistible. As a result, mid-market companies across a vast range of industries are finding themselves under threat, and many aren’t ready to respond.

As these companies continued to focus on financial engineering instead of innovation, they all began to accumulate what we refer to as digital debt.

What is Digital Debt?

Digital debt refers to the consequences a company faces when it fails to invest adequately in its technological infrastructure or innovation. This can lead to a loss of competitiveness, decreased efficiency, and a lack of adaptability in the rapidly evolving digital landscape. Just like financial debt, digital debt accumulates over time and can impair a company’s ability to innovate and compete effectively in the long run. Considering digital debt when acquiring a business is crucial because it directly impacts the company’s future performance and potential for growth.

Impact of Digital Debt on Acquisitions

Technology Due Diligence has become an essential feature in the acquisition process. When purchasing a business digital debt can arise from outdated systems, legacy software, or inadequate cybersecurity measures. Assessing the target company’s technology infrastructure is crucial to understanding and mitigating these issues, ensuring a smoother integration process.

It’s important to negotiate a fair purchase price that reflects the additional investment or resources needed to address the digital debt and bring the technology up to the desired standard. Adjusting the consideration for digital debt involves evaluating the extent of technological challenges within the target company. It’s important to consider factors like outdated systems, cybersecurity risks, and the cost of upgrading.

7 Practical steps to address the Digital Debt challenge:

• Clearly define responsibilities for addressing digital debt in the purchase agreement, outlining timelines and milestones. This proactive approach helps manage risks and ensures a more accurate valuation of the business considering its technology challenges.
• Conduct a risk assessment to identify potential vulnerabilities in the target company’s digital infrastructure. This evaluation can help quantify the impact of debt on the overall business operations and financial performance.
• Factor in the time and resources required for a smooth transition and negotiate a realistic timeline for addressing the identified issues. Involve your own IT team early in the due diligence process to ensure a comprehensive evaluation and effective integration plan, minimising disruptions and maximising the value of the acquisition.
• Look to create agreements with the help of legal and technology experts that provide safeguards and contingencies, protecting your investment against unforeseen digital challenges. Comprehensive understanding and strategic negotiation are key to effectively adjusting consideration for digital debt.
• Assess the scalability of the existing IT infrastructure and its alignment with your long-term business goals. Determine whether the digital debt can be turned into an opportunity for innovation and improvement.
• If the target company’s technology assets hold strategic value, incorporate this into the consideration. Seek expert advice on the potential impact of digital debt on customer relationships and data security, addressing these aspects in the negotiation process.
• Explore potential synergies between your existing technology assets and those of the acquired business to streamline integration efforts.

By taking a holistic and strategic approach, you can optimise the adjustment of consideration for digital debt and enhance the overall success of the acquisition. If you have any queries about technology due diligence, or due diligence in transactions, please do not hesitate to get in contact with Ashok Thomas, or a member of our Corporate Finance Team.

This blog is part of our Due Diligence series! If you’ve missed the first of the series don’t worry our first blog on due diligence is here.