Cybersecurity Stands as Big Sticking Point in Software M&A

The mergers and acquisitions (M&A) market for software broke a lot of records last year, as investors took advantage of the convergence of cheap money and of society's growing dependence on software in every facet of personal and business life. But as the feeding frenzy continues, there's one big sticking point that rears its head more frequently than any other deal blocker in the software M&A game: cybersecurity.

A new study out today by West Monroe Partners and Mergermarket shows that cybersecurity issues frequently make problems both during due diligence and after the close of software M&A. The study found that cybersecurity was the number two reason why software deals were abandoned, only behind compliance, which in itself is usually wrapped up with existing security concerns.  

Meantime, more than half of respondents to the survey say that they discovered a cybersecurity problem after a deal closed, indicating that there's still lots of room for improvement in how well acquisition targets are scrutinized for security problems before stakeholders sign on the bottom line.

"It's a messy problem right now and the more competition in the marketplace the bigger that problem gets," says Sean Curran, senior director in West Monroe's security and infrastructure practice.

Curran explains that because the power of the marketplace is frequently with sellers who are often courted by a number of firms, they're much less likely to provide the necessary access to information and resources to conduct cybersecurity due diligence.

It's likely why the 16% of survey respondents say they were displeased with past experiences conducting cybersecurity due-diligence, compared to just 1% each for other forms of due diligence such as technology or operations. 

Nevertheless, the frequency of cybersecurity due diligence is on an upward trajectory. At Curran's firm, about 65% of the transactions they consult on each year now include some security due diligence - compared to zero just three years ago.

Technology attorney Randy Sabett agrees that security diligence is being brought up in greater frequency across not only many different types of M&A deals but also other types of formalized business agreements.

"We are seeing on an increasing basis situations where the acquirer says 'Hey, this is a big issue to me. I really want you to dig in on it,'" says Sabett, who is special counsel for Cooley LLP in Washington D.C. "In other cases, it's one of those things where the acquiring entity might say 'Yeah, it’s an issue, but just make sure that they have done the things that they should have done.' Not necessarily quite check the box, but not a deep dive. Somewhere in between." 

Both Curran and Sabett agree that one of the biggest impediments to a smooth transaction is the discovery of an ongoing or recently uncovered breach. Last year's announcement of a massive data breach at Yahoo that came right in the middle of the firm's buy-out by Verizon is a poster child for this. The previously undisclosed breach ended up leading to Verizon knocking a massive $350M off of its purchase price of Yahoo.

According to the survey released today, over 35% of respondents reported cybersecurity or compliance issues as the number one issue that led them to walk away from a deal. Sabett says that even if these two issues don't directly lead to an acquirer wanting to walk away, they can cause a cascading effect of consequences that can put a deal in jeopardy.

"They're the types of things that can crater the deal process - not necessarily the deal itself but they may significantly increase the time to close or maybe even change the deal terms in one form or another," he says. 

According to Curran, beyond that, some other significant findings in diligence that can impact a deal include the unprotected storage of data, hoarding of very sensitive data, and the complexity of fixing issues to meet the acquirer's risk tolerance levels. Take the case of software firms: if vulnerabilities exist within the fabric of the company's core architecture, that could be a big problem. 

"It really comes down to risk tolerance and why you're planning on buying the organization," he says. "If I have to redevelop the software from scratch to remove those weaknesses, then is it really worth me buying the product that I ultimately have to reguild anyway? Or am I better off finding a competitor?"

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