How tech debt impacts private equity investors

By Eric Bragg and Ben Bacon

Poorly managing tech debt can have profound implications from a valuation and investment–return perspective for private equity firms. IT infrastructure, and its ability to effectively serve an organization, continues to be a core source of investment value for private equity investors. While every organization is navigating how to manage tech debt, the challenge for portfolio companies and their PE firm investors is understanding how to identify, manage, and value it.

What is tech debt?
Tech debt is a term originally earmarked for identifying software code gaps. In recent years, the meaning has shifted to “all technology modernization, update and repair needs.” Ineffectively managing tech debt handicaps an organization’s ability to remain competitive. Outdated, legacy IT environments create increased complexity, resources, and cost, stifling a company’s progress toward growth and expansion.

Rather than delivering scale and efficiencies, an inordinate amount IT time, effort, and cost is spent maintaining legacy environments. This can have a material drag on investment return value for owners.

Tech debt principal and interest
From a balance sheet perspective, tech debt is broken down into two components: principal and interest.

• Principal: Required work and spend that must be done to modernize the entire IT environment.

• Interest: Required work and spend to maintain the existing IT environment in managing risks and needs of the business that continuously arise (sometime referred to as the complexity tax).

According to a McKinsey survey, tech debt can extinguish the contribution of technology toward organizational goals by up to 40%.

To make matters worse, tech debt spills over into budget deployment, where nearly three-quarters of those surveyed bled at least 10% of their new-project spend to addressing hinderances created by tech debt.

The troubling trend with tech debt
With such a deep percentage of spend sliding over to addressing tech debt, firms are facing a harsh reality: large sums of capital are going toward unpaid debt. The overarching sentiment amongst technology CXOs is that this problem is only worsening—they see tech debt driving sharply upward. If IT spend goes unchecked from a tech-debt perspective, private equity firm investors will take painful valuation hit.

This silent siphoning of IT budget and resources created by tech debt can often be confounding to CFOs and board members. Modernization efforts carry a tangible investment in capital and resources; it can be hard to weigh the slow drain of the status quo against a clear modernization strategy.

There is, however, good news: Tech debt can be a value creator.

Effectively managing tech debt can be a value creator
Firms are advised to take a realistic approach; the goal should not be to myopically focus on zeroing-out tech debt. While levels that are too high can significantly handicap an organization, a balanced approach is recommended: determining the areas of greatest impact and addressing those first. In this manner, tech debt can be a very useful way of leveraging the IT environment, guiding them to most effectively serve the business, driving greater investment return value for private equity owners.

Leadership teams and their boards must make it a common practice to measure and manage tech debt as a part of rolling performance management reporting. This data should be used by private equity owners to ensure that IT is a value driver in their efforts to manage towards a successful investment exit.

In our next post, we will analyze ways that tech debt can negatively impact firms during exit, as potential merger or acquisition partners are rapidly growing ever wiser in their investigations into an asset’s technology footprint during due diligence.

About the authors

Eric Bragg is a Senior Managing Director with Infor’s Private Equity Practice. Eric’s 30-year career in private equity includes roles as Managing Director at Deloitte Consulting’s HCM and SAP practices. As Alliance Director at Kronos, he collaborated with colleagues to establish private equity as a channel.

Ben Bacon is a Managing Director with Infor’s Private Equity Relations Team. In his 20-year career, Ben has worked alongside hundreds of brands as a member of a variety of advertising agencies, global technology companies, and software leaders. He is in his fourth year with Infor, where he helped establish the analytics practice for private equity.