Optimizing EBITDA With a Systematic Approach to IT Capitalization

August 12, 2020

Falcon’s Success Stories cast a spotlight on private equity-backed operators and the tools and tactics they leverage to create real value. In each entry, a world-class executive details a practical solution to a critical business issue. To be featured, contact us with the subject line “Success Story“.

Executive: Finance leader at a private equity-backed technology company.

Challenge: Lack of an upfront process to identify and track IT projects capitalizable under GAAP.

Solution: A consistent touchpoint between finance and IT to recognize capitalizable projects. Utilization of IT’s existing project management tool to create an auditable paper trail.

“Most accounting groups are not proactive in the way they approach the business side of the house.

The typical approach is purely reactive – the numbers come in, and then the accounting happens.

But that approach results in missed opportunities to optimize EBITDA. Capitalization can be a huge driver of EBITDA, particularly in a private equity-backed environment. But if the intent to capitalize something is not established from the outset, capturing that value becomes far more difficult.

Last year, we committed to a more proactive, strategic approach to capitalization across the organization. The overall impact is projected to be over ten million dollars this year, with over six million realized to date.

One of the most important initiatives centered on pre-emptively identifying what IT projects qualified for capitalization. That would allow us to create a process to ensure related expenses and man-hours were logged in such a way to produce the optimal result under GAAP. The process needed to create an auditable paper trail robust enough to stand up to scrutiny.

Buy-in from our IT team was essential. Finance needed to drive the desired behavior, and that can be out-of-the-box for traditional finance people. However, we’re the ones who understand the desired outcome and how to optimize that result. If we don’t share that wisdom, there will be missed opportunities for the entire organization.

One of the big challenges was figuring out how to get IT employees to log their hours in a way that finance and accounting could see the amount of time being spent on certain projects. You need that detailed, accurate data hygiene to get the best results.

The key for us was leveraging existing processes so IT didn’t have to start doing something they weren’t already doing. I think that’s important for any cross-functional project.

We worked closely with the IT manager to explain how optimizing our EBITDA positively impacted the whole organization. We went over the guidelines around software development capitalization under GAAP and talked about how adding new functionality was a key requirement.

For example, revamping an entire plug-in is a capitalizable project because it’s as if you’re developing something in-house you would otherwise have to go buy. But if you’re just fixing a bug or adding an extra item to a drop-down menu, that can’t be capitalized.

We established a monthly cadence that allowed finance to come together with IT in order to learn what was on the product roadmap and identify capitalizable opportunities. Doing this upfront allowed us to label the projects correctly and insert the appropriate terminology to show GAAP compliance in the front-end record so when auditors looked into it at year end, it was already baked in with an adequate level of detail.

Every tech company has an IT department that’s working on different projects, and they’re most likely already using some sort of project management tool. We knew our IT folks use a software called Jira to manage their projects and log their time. When a project is deemed capitalizable, that now gets coded into Jira, so when someone works on a related task and logs their time, they simultaneously create that necessary paper trail. That data is then double-checked with the IT manager and given to the corporate controller.

Finance is ultimately the arbiter of what is and is not capitalizable, but we rely on IT and their knowledge of project outcomes to help make those decisions. Much of this remains invisible to the folks doing all the coding, as it should be. Allowing coding teams to make the decision on whether or not projects are capitalizable would be a control issue.

It took some time to get the process down but now we’re really clicking. This was not something IT was going to bring to us. Traditional finance teams can be hesitant to engage in operational processes, but when done the right way, the investment often pays off many times over.”

Action Steps

  • Facilitate a stronger partnership between finance and IT. Finance leadership must educate IT on the requirements and potential benefits associated with capitalization. IT leadership must educate finance on the details of their current product roadmap and any upcoming projects.
  • Investigate how existing systems or processes, such as current project management tools, can assist in the effort to identify and take advantage of opportunities for capitalization. 
  • Establish a regular cadence to refine these efforts and ensure the requisite steps for GAAP optimization are being executed.   

Falcon provides C-suite talent solutions for middle-market private equity firms across North America. Follow us on LinkedIn.