Three hidden private equity value opportunities in software deals

1. How private equity can use due diligence that can enhance product roadmap governance and commercial success post-close

Transaction data analysis by an EY-Parthenon team indicates that approximately 30% of software companies do not follow leading industry practices around product roadmap governance, resulting in acute challenges related to managing how development teams are spending their time. Companies often struggle with appropriately prioritizing roadmap initiatives, ranging from tech debt remediation and new feature development to product enhancements. The data also show that companies’ product roadmap objectives and broader product strategy can often be misaligned. As a result, companies are often poorly prioritizing R&D investment, which can be detrimental to commercial strategy. For instance, a company may be working on a feature that customers have not shown interest in. Or a company may be prioritizing work on minor feature enhancements while competitors are working on brand new, innovative features that will differentiate them in the marketplace.

During due diligence, PE firms can take specific steps to scrutinize a company’s product strategy and product roadmap:

• Assess whether future roadmap items are tied to the broader product strategy and understand whether regular roadmap reviews are taking place and – if so – how roadmap initiatives are being prioritized. For instance, by determining if current or prospective customers have committed to using a new feature once it becomes available, companies can identify the most impactful areas for R&D team time investment, with the goal of improving current customer satisfaction and the chances of landing new customers. By placing go-forward roadmap items into buckets such as “competitive requirements,” “growth initiatives,” “minor feature enhancements,” and “maintenance and technical debt remediation,” a company’s R&D investment philosophy can be identified and evaluated. PE leaders can then better understand whether a company is under- or over-investing, and what may be motivating those investment decisions. For example, a company might have more technical debt, or fewer major new features planned, than expected.
• Evaluate historical roadmap delivery to understand if upcoming product commitments are realistic. Particularly during M&A due diligence, it is not uncommon for a target company’s management team to make lofty claims about how soon a new product or a major new feature will be ready for release. If there is a major roadmap item whose timely launch is critical to sales growth, but the company has a demonstrated history of missing deadlines, a private equity investor may need to consider a temporary increase in R&D spend beyond management’s projections or delay other roadmap items to set a more realistic timeline for a large initiative.
• Identify whether the company tracks feature usage, post-release, to understand customer adoption. Investors should understand how the company uses data to help refine product strategy and identify future roadmap initiatives to support increased product differentiation.

Critical questions private equity fund managers can ask in software due diligence:

• Is the company’s roadmap of planned and new product features mature and clearly aligned to management’s stated product strategy and market needs?
• How does the company develop its R&D investment plans and align development priorities with customer priorities?
• How can the company improve predictability of software delivery timelines and ROI by tracking metrics on R&D progress and velocity?
• Will the company be able to increase portfolio integration and cross-selling by improving collaboration across software R&D teams, especially as part of an inorganic growth strategy?
  

2. What software R&D metrics can do for private equity portfolio companies

Of the 180 deals analyzed, two-thirds involve companies that did not have KPIs in place to track performance in the R&D organization, which can be an opportunity for private equity investors to build higher quality software faster and improve time to market by investing in developer infrastructure, tooling and testing processes.

PE portfolio companies can push for greater adoption of various tracking metrics, such as roadmap delivery history, scrum team velocity, defect escape rates, automated tests and other metrics. These can be highly correlated with predictable software delivery and software development lifecycle (SDLC) processes, the EY-Parthenon team’s analysis shows.

Proactively and quantitatively tracking development progress can help R&D leaders better align software development timelines with commercial plans to develop new features for customers. Automated tracking of KPIs can inform personnel allocation decisions to mitigate delivery risks, support initiatives to reduce development costs, and help plan and prioritize future roadmap initiatives based on existing capacity and developer velocity. Similarly, tracking performance metrics can help R&D teams proactively prevent incidents tied to reliability, performance and security, which can improve customer satisfaction and potentially mitigate customer churn.

3. Why R&D collaboration can help product integration and cross-selling

Many of the private equity-owned companies EY-Parthenon teams have assessed and worked with have conducted meaningful software M&A activity to build a robust product portfolio. But transaction data analyzed by the EY-Parthenon team show that companies often do not pay enough attention to integrating R&D talent from these acquisitions. This can result in software development practices that vary across the organization. Of companies we recently evaluated as part of a due diligence engagement, a majority executed at least one M&A transaction in the past three years and a majority of those did not have a cohesive or unified product portfolio. This opens up the following post-close value creation opportunities for PE investors: 

• Tightly integrating R&D teams can help companies be more successful in combining products into a cohesive offering with stronger cross-selling opportunities. Removing R&D silos by better integrating teams can loosen trapped capacity and enable people to share expertise across adjacent development efforts.
• Reducing delays in delivery timelines and bringing new features to market by:
  • Setting up recurring cross-team touch points
  • Establishing a chapter-and-guild model to provide teams with an outlet to share leading practices and promote process standardization across an organization
  • Reorganizing teams across value streams (e.g., parts of the platform or release cadences) to create natural boundaries for teams to be self-sufficient and to minimize external dependencies
  • Building documentation repositories to facilitate knowledge dissemination and to create an audit trail for the key point of contact/collaborator
• Formalizing “company norms” to improve collaboration can be helpful, especially for R&D teams located across multiple geographies. In addition, co-locating teams for a temporary or extended period can increase knowledge transfer and development efficiencies, and long-term centralization of full-time staff can reduce time zone-related collaboration challenges.

Valuation multiples can be rich within the software sector. It is incumbent on private equity investors to identify areas of value creation opportunity early in the acquisition process. Some of these opportunities may not be evident at first glance but can be identified during M&A due diligence with thorough investigation and analysis.

Thank you to Senior Associate Naina Wodon in the EY-Parthenon Software Strategy Group, Ernst & Young LLP, for contributing to this article.