Many investors today understand the importance of having IT due diligence in place.
However, a majority still don’t take this vital step. As a result, they suffer the consequences – a higher risk of future technology issues, liabilities or cyber security issues.
This is a continuation of the post on preparing your early-stage SaaS/Technology business for IT Due Diligence.
The previous post provided high-level guidelines on preparing for IT Due Diligence, and this article highlights common observations we see when assessing firms.
Below are some common issues and observations we uncover during IT due diligence and some suggestions on how to address them:
1. Unclear Return on Investment.
In early-stage businesses, the technology strategy and product roadmap are typically presented with little financial attribution.
Yet time has been spent to develop a full financial model to support the investment. At a minimum, we need this information from the pitch deck to be added to these documents.
As a financial model has been developed the entire business, we can assume the required financial skills are within the team.
The same skills are needed to expand the Product Roadmap to describe how funds will be deployed against the tech team, the cost to develop the key features and the assumed return on investment.
2. Wage Inflation
During IT Due Diligence, we are seeing wage inflation is causing significant headaches for management. As a result, we easily see an additional 30% in headcount fees, often more.
Plus, early-stage businesses also have to remember that new additions to the team are unlikely to be as productive and, therefore, cost-efficient as the original core team.
The solution will depend on how mature your business and technology solution is. For some firms, the technology is mature, so they project minimal technology spend.
But where more funding is needed to develop the technology, you will need to (a) build wage inflation into your plan, (b) present a plan for employee retention and (c) a realistic perspective on how effective new hires will be compared to the original core team.
3. Tech Debt
Startups are the adolescents of the business world, and some pay minimal regard to the trail of ‘tech debt’ they leave in their trail as they chase customer features.
During IT Due Diligence, this concern can be found by assessing the code, components, repo’s etc.
The longer this problem is left to grow, the bigger this monster of an issue becomes and the more expensive it becomes to fix.
You need discipline within the tech team to continually improve your debt position.
Creating tech debt isn’t an accident; it tends to be a strategy of a high focus on customer value – i.e. bringing new product features to market quickly.
Eradicating Tech Debt is not something you can accomplish before a deal completes, but seeing evidence that you have awareness of the types of debt (e.g. code quality, component sprawl, etc.) and an approach to address it is key.
4. Serial entrepreneurs
Some entrepreneurs make a career selling businesses – a.k.a ‘flipping’ technology firms. Hence:
- The longevity and intention of the venture are questionable.
- Hence the quality of the offering is poor.
- Sustainability is not high on the agenda.
Of course, the entrepreneurs themselves are not a concern.
But we are looking for those that have built something to ‘flip’, and if built quickly, we need to understand how well it has been built. In the worst cases, buyers have had to rebuild entire platforms after a deal.
In these cases, we look at what happened post-acquisition with the last few they sold. Did that hockey-stick growth happen as projected/promised?
5. Buzzword bingo
This is more an amusement than a real problem because it’s so easy to debunk. But targets lose respect when they describe their 50 lines of VBA as “Machine Learning”.
We’re not kidding.
Learn more about this breathtaking and sad tale from this Secret Leader’s Podcast Episode.
We can genuinely assume none of the investors undertook IT Due Diligence, as this type of issue would have been uncovered, easily.
We understand the investment is needed to deliver against your vision. But be realistic about what is possible today and let your DD assessor know what is missing -as they might be able to present the ‘gap’ as an opportunity for the investor.
6. Architectural opaqueness
We may find the team struggles to describe the system architecture, to any meaningful depth. Meaningless block diagrams created for a sales slide deck or the inability to articulate the architectural components will raise an eyebrow.
- Inability to articulate how the architecture operates.
- Lack of diagrams/documentation.
- Raises concerns if the team are the right people for the next stage of growth.
Either document or practice whiteboarding both the product and tech diagrams. Following this, ensure you have presented the architecture internally before DD to practice and iron out issues. Effectively – practice and be open to challenge.
7. Professional Services
Uncertainty on how to present Professional Services fees. Some firms need to charge PS fees to implement their solution; this can often contribute 50% or more of revenue.
- Professional Services needed to implement an early-stage product.
- Professional Services currently a significant contributor to revenues.
- The team want to eradicate Professional Servics with the next round of funding.
The uncertainty revolves around whether you want to present a ‘pure SaaS’ solution with high scalability (the utopian view of tech) or to proudly state that a PS team will grow in line with business growth.
Not all firms can be ‘pure’ SaaS.
And some, especially when serving B2B Enterprise, will benefit from a high level of human interaction to keep business relationships ongoing.
So present your revenue lines and offerings based on what suits your market, customer and product – not based on a utopian view of self-serve SaaS offerings.
8. Poor IP Protection
During IT Due Diligence, it is clear some teams think storing everything in the cloud is enough. It isn’t – use tools to backup your code repositories and data elsewhere.
- Basic assets (e.g. brand, company name, logo etc) not trademarked.
- IP agreements between staff not in place
- No NDAs, employment contracts etc.
- Lack of data backups (inc. code repositories)
Some of these observations cross over to Legal Due Diligence. From a technology perspective, how well are you protecting and backing up your IP?
The main barriers tend to be awareness and focus, and they are all easy items to fix post-deal.
9. Growth plan dependent on free cloud credits.
This is a significant risk, especially if coupled with a lack of cloud cost optimisation and a belief cloud is cheap (it isn’t). So what happens when those credits run out?
- Financial Model relies on free cloud credits from vendors.
- High-risk cloud usage is not price-optimised.
- If standard pricing kicks in, the ratio of technology costs can be unsustainable.
Ensure your financial model (a) indicates the duration of your free cloud credits, and your risk register states the cost and remediation actions.
Ultimately be prepared for additional costs.
10. Poor resilience.
Single Points of Failure are common in many SaaS firms assessed. Typically the board/senior leadership team are unaware of this risk.
If your product fails, you don’t have a technology concern – you have a brand reputation one. Often the CTO is aware of the points of failure, and there haven’t been enough resources to address them.
The issues would have been mentioned to the management team but often soon forgotten as the customer base increased.
This is a key benefit of IT Due Diligence as an investor can help bring this type of issue to the forefront and resources to address it.
Most of these issues can be assessed and managed before outsiders are asked to evaluate your business.
These are just a few examples of the common issues we tend to see during IT due diligence – and whilst the impact on the business and investor will vary, the main benefit is to raise these issues and to get the support you need to fix them.
For more information, read more about our IT Due Diligence Service.