Exploring Cybersecurity Due Diligence in M&A

Cybersecurity Due Diligence Drives M&A Activity

The cybersecurity market is growing at a tremendous rate and offers significant lift to companies in the sector. With data breaches affecting more than half the world’s population, companies must prepare for cyber threats at every level.

This is why strategics and financial sponsors are actively looking to acquire cybersecurity firms. However, with valuations thawing from the sky-high valuations seen in 2021 and 2022, dealmaking has slowed considerably.

Buyers

The demand for cybersecurity innovation is high, a factor that has helped drive market-beating transaction valuations. Unlike other technology sectors, which have seen investors become cautious as economic uncertainty has weighed on stocks, private equity and strategic buyers are continuing to invest in the industry at a steady pace.

These strategic and financial buyers can be publicly traded companies seeking to add security capabilities or technology-driven firms looking to expand into the space. They can also be investment groups looking to purchase a platform acquisition in the sector and grow it through add-on acquisitions with the goal of generating a healthy return on their initial investment.

For all of these reasons, it’s important for purchasers to thoroughly evaluate a potential target’s security posture and to understand any history of significant cyber breaches or digital infections that could derail the deal’s anticipated value. Such issues are not only a risk to the acquirer but also can be disruptive to ongoing operations and impact brand and growth opportunities.

Targets

During the M&A process, serious cyber breaches could devalue a target company by exposing intellectual property to attackers and creating operational risks such as lost revenues, profits, market share and brand value. In order to mitigate these risks, M&A teams need to conduct thorough cybersecurity due diligence on the targets.

This process can uncover a host of issues from unreported data breaches to sensitive credentials leaked on the dark web, all of which can have a significant impact on an M&A transaction.

Increasingly, large tech companies, even those not traditionally in the cybersecurity space, are buying security firms to help protect their own data and customers. For example, in early 2022, Recorded Future acquired SecurityTrails to enhance its attack surface monitoring capabilities and Google Cloud bought Siemplify to improve its security orchestration, automation and response (SOAR) offerings. Add-on acquisitions are an ideal way for strategic buyers and financial sponsors to expand their portfolios while limiting the risk of integration post-deal.

Valuation

While there are a number of headwinds that can impact the cybersecurity market, it is important to remember that buyers and financial sponsors are actively seeking opportunities in this space. Regardless of the macro environment, this sector continues to grow and offers attractive valuations for owners.

Strategic buyers and financial sponsors are looking for stability, profitability, growth and scale, and the cybersecurity sector provides those fundamentals. Additionally, the majority of cyber security companies are recurring revenue-driven and generate consistent EBITDA margins.

In addition, a significant portion of the cybersecurity M&A activity in 2023 has been driven by private equity, which provides additional support to these companies. Given the current capital markets, this is a welcome change from previous years where strategic buyers have dominated M&A activities in the sector. Private equity firms are pursuing add-on acquisitions, as well, which will further fuel M&A activity in the cybersecurity sector. For CISOs, this increased M&A activity means that the bar for a strong cybersecurity posture is higher than ever.

Integration

During the M&A process, cybersecurity due diligence is a comprehensive evaluation of a target company’s security posture. It homes in on the strength and maturity of its security defenses, as well as its data privacy policies and incident response plan.

A CISO can be an asset in this area, helping to ensure that any M&A deals have solid security systems in place before the deal closes. This helps to avoid any rude surprises down the road that might impact both productivity and profitability.

M&A is often a flurry of activity, and if serious cybersecurity issues are left behind or neglected during this time, they can become an ongoing concern for both the acquiring and acquired firm. This is why a strong cybersecurity strategy and M&A plan are critical for businesses looking to expand in 2023. A robust M&A strategy helps CISOs add value and control risk during the M&A lifecycle, from pre-deal due diligence to post-deal integration and operations.

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