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| Uncovering Hidden Financial Assets in Your IT Organization
Part 1 of 3: Current Trends in the Valuation of IT
CIO Handbook #24 Code Exchange, Inc.
Introduction Do you want to surprise your CFO with positive information for once? Do you want to increase your IT budget next quarter without any needed approval? Do you want to improve your company’s balance sheet by quarter end? Do you want your IT group to add significantly to the financial value of your organization? Many CIO’s are sitting on a vast pool of unrecognized financial assets. In this article we address the current trends affecting the valuation of IT. In the next two parts in this series, we address where the value is and how to quantify and utilize these assets.
Current Trends in the Valuation of IT The IT organization is under a new form of review that has been gaining a focus in more recent years. IT departments and organizations are now being evaluated separately and can significantly add to or decrease the financial value of the overall company. Along with these trends, comes the new ability of the IT organization to generate its own revenue sources and assets for the company. Below are the recent financial and technical marketplace trends adding to this growing inspection of the IT organization and the potential of IT to create its own revenue streams and asset value.
Private Equity and Mergers/Acquisitions Although the pace of private equity investment has been sporadic in the last 24 months, this private equity investment trend has left its lasting mark on how IT departments are looked at. In order for a company to be attractive for an acquisition or Private Equity Group (PEG) investment, your IT overall costs will need to fit into acceptable “percentage of revenue” industry benchmarks. You need to know what these benchmarks are and if costs are not in-line, you will need to give a precise explanation (often valid) as to why to any outside PEG. As Code Exchange has personally seen hundreds of times, if IT costs are over competitor norms, this will either deter PEG’s from investing or encourage them to invest as they see an easy cost savings by slashing IT costs in the organization to boost the company’s overall profit immediately after an investment. If your company’s product mix is strongly influenced by custom software or ecommerce presence, expect a thorough review of these applications as part of an acquisition or PEG investment. Code Exchange has performed many application evaluations for PEG’s, and has seen several times where it has increased the investment price of the company, and only a couple times where it has decreased the investment price of the company. Be sure you know the true value of your applications and how they are being positioned before any review takes place. To discover how to properly assess and value your applications and ecommerce segments, see the next two parts in this article series.
Bank and Debt Rating Agency Valuations Every company today has bank loan agreements, line of credit agreements, has outside investors, or has issued rated debt instruments. Any of there financial transactions may raise the possibility that your IT organization has already been evaluated for general risk to the value of your company. For example, if you are a company that issues any rated debt instruments, your IT organization was already given a preliminary risk rating whether you realize it or not. When the major debt rating agencies are giving your company a rating, they all are now including a risk value in their calculations on the chances your company will have a major IT security breach, the need for a large IT capital expense in the near future, IT outsourcing in a low rated countries, and the general state of your IT organization and the industry it is in. These IT evaluations, as part of the company rating process, are quickly becoming more common and direct, to the point of involving the CIO in these financial valuation processes.
Intercompany Transactions Another trend that is occurring is the greater investigation and auditing of intercompany transactions. For the purpose here, an “intercompany transaction” is defined as a transaction between two closely related or affiliated companies, which may or may not report up to a consolidated company. If you have various entities within your organization using an application/hardware or have a shared services type of IT environment, your chargebacks to these individual entities must be close to a fair market value in many company structures. Therefore, you must have information of how the chargeback value was derived. Do you know what the fair market value cost for this entity to use one of your applications, services or hardware is? To discover how to properly arrive at this value, see the next two parts in this article series.
Intellectual Property is Hot The Dotcom era has made Intellectual Property (IP) a focal point of the technology world. The positive result of this trend is that an IT organization can add to the value of the organization by applying for and receiving patent or copyright protection for developed applications and processes. The negative result is if you have developed any major applications or IT processes, you are most likely violating some outstanding IP held by other companies. With the IP rights mess in technology right now, it is almost impossible to develop an application from scratch that is not in violation somewhere. This violation is often of no concern until an outside review takes place, your IT application/process gives your company a public competitive advantage, or an IP holder starts to run the “IP shakedown cycle” as we have seen many times in the last few years (Linux kernel, One-click shopping cart, VOIP, data sync, etc.). In addition, it is only a matter of time until one of the IP consolidation companies begins the “shakedown cycle” on a very common use IP protection that will affect one or many of your current applications. Also, if an outside consulting firm or vendor did the development; this does not lower the risk, and may even put you at more risk as copyrighted or patented source code and methods may have been reused in your environment without your knowledge. If your IT organization has not applied for or does not currently hold any patents or copyrights, something is wrong. Often, what could be one of the greatest assets in the IT organization goes completely unrecognized.
Virtual Applications Virtual applications are finally here and becoming more common. Virtual applications are essentially applications, services or components that can be configured, moved or shared without a change to the underlying application. The Web Services and the SOA movement have helped bring this to a realization, but we are also now seeing entire applications move between companies that don’t match the Web Service or SOA accepted standards. Many custom developed applications or integrations can be “productized” and sold to related companies or to an outside company altogether, either as a service or as an outright sale. When you develop your applications/integrations, you should be asking yourself two questions: • Could this application/integration/service have value outside my organization? • How do we develop and package this application to become more “productized” and “saleable”?
Security In recent years, you don’t have to look far to see how a security breach can impact the value of your company. There are about a dozen publicly disclosed security breaches every week by major companies. Therefore, the value of your company is influenced by the quality of your data security risks and procedures. Your company is being valued on how likely it is that a major security breach will occur. We are starting to see formulaic models developed by valuing organizations to help quantify the risks of a breach to your company. Many of the variables in these equations are influenced by the quality and methods of your IT procedures and standards.
Part 2 of 3 in this series of articles covers “Where the Financial Value is in Your IT Organization” Code Exchange is the innovator in the newly created application code marketplace and provides unsurpassed dedication to its clients and exchange members through a suite of independent application code transaction and valuation services. For sellers, Code Exchange can provide a number of services which help value and prepare application assets for the market; for buyers, Code Exchange will assist with need analysis and cost-benefit analysis for development vs asset acquisition. Once sellers have assets ready for sale, and buyers have identified their needs, Code Exchange facilitates matching for both sides and provides broker services to ensure a smooth application asset transaction for all parties involved.
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