As an investor, when you’re performing your due diligence on a tech company, the “art” of the deal comes into play. You’re not just looking at hard facts and figures; you’re also assessing the team, their ideas and how they’ll execute. So, of course, that’s where due diligence providers come into play – using their expertise to advise you on the risks and opportunities within potential investments.
But it’s still your decision to make. This is why we’ve put together a list of essential questions you should ask during your due diligence process. These will help you better understand the team, their plans and whether they have what it takes to execute their vision.
This is where creativity and experience come into play, often setting successful tech investments apart from the rest. That’s why I don’t believe in a “set list of questions.” Every investment is different, and your questions should be tailored to the company you’re examining. However, there are some key things you should always keep in mind during Technology Due Diligence.
Tech Due Diligence is more than a list of questions
Checking Google to see what the most requested topics are regarding technology due diligence, many people are looking for checklists and templates, as per the screenshot below:
But Tech Due Diligence is much more complicated than going through a pre-defined checklist – as technology and the value it presents is a complex, organic and creative endeavour that is difficult to assess with YES/NO answers. At the same time, it is critical to be assured the team that provides the assessment has worked through all the vital information and data to make a balanced judgement.
We also believe that running these technology assessments cannot be sold by partners and then delegated to junior staff. Instead, the people who assess technology need to have had C-Suite responsibility and sat on both sides of a PE deal. Ensuring they have the tech, people and commercial knowledge to make relevant observations and judgement and present the findings to senior execs across the deal.
A tailored diligence scope is essential for success
So instead of wading through hundreds of pre-defined questions, creating a high-level scope tailored to your deal is better. Typically this starts by understanding:
Your Investment Thesis
We must determine how we can genuinely help you and not undertake an expensive ‘check box’ exercise. So we need to understand the rationale for the deal, the assumptions you are making regarding the technology and the team that builds and operates it.
The first discussion about the target business will outline the essential details such as the type of deal, e.g. Growth Cap, Buyout Secondary etc., the industry, the size and discussion regarding the team and the underlying technology. For example, suppose terms are being written up, and technology due diligence is on the horizon. In that case, we can assume that the management team are talented and collaborative, and there’s a decent business opportunity on the horizon.
But we need to know what value you believe the technology contributes to the business and revenue and any assumptions you are making about how the tech operates based on the conversations you’ve already had. Again, this is not to say those assumptions are wrong, but we will be sitting between you and the target, and we need to understand both perspectives to be the most impactful.
Typically, the tech is providing the value and operating as claimed by management, but scaling or cyber-security concerns today need addressing to meet the investor’s expectations. As a result, it is not unusual to work with associates in the investment firm to produce a detailed scope based on the information memorandum/pitch deck.
A good scope should ideally:
- Outline and detail all key themes for the engagement; we typically see seven themes
- Specify the timelines and critical meetings to get things going
- Who are the key stakeholders and those on the In The Know (ITK) List?
- Describe the 5-7 key questions specific to this target
- Take on board the investor’s preferences for the final report
- Agree how key observations will be presented
- Agree on the management briefing timings, whether in person or over VC etc.
- Remind the investor that the scope will probably change after the first two or three meetings
Moving forwards, the key questions we tend to see are detailed below. They are informal, underlying questions that are typical in a review but note a project scope would not be presented by us this informally:
Is the technology ‘real’?
With smaller or growth capital deals, the technology may still be in its infancy, so it’s fair to be considering this question. Especially with a team presenting unique capabilities and the varying interpretations of what ‘artificial intelligence’ is and how it can create business value. Therefore, it makes perfect sense to de-risk this concern for future investors and reassure them of the current tech stack and the plans to enhance it.
But contrary to belief, this question is valid, even with mature businesses in large deals. For example, we have seen situations where the core IP that was a key value driver were not created by the target or unique intellectual property owned by the firm. In one case, this was due to employees moving on and others not fully understanding some of the dependencies and agreements made in the early formation of the business and technology solution.
Is the tech any good?
This is possibly a controversial and unfair question for the target, but it is a common underlying question that will undoubtedly be discussed during the management briefing.
As diligence providers, we are usually sat between two parties with different perspectives, yet both want the same outcome. Management tends to present a positive and cost-effective technology outcome, and the investor prefers to see a more balanced view that demonstrates some form of risk management has been considered.
Hence the ‘is it any good’ question is an opinion based on a thorough, time-limited assessment of the entire technology department or function. We respect that if a firm has PE attention, for the first or subsequent time, there’s undoubtedly something ‘good’ happening, but we also have to keep an open mind that issues may be uncovered that may stall the deal until resolved.
Ultimately we cannot provide a purely subjective answer to this question. Much work and information are needed to ensure all critical areas of the business technology are assessed, considered and pieced together to provide a macro view for the investor.
How easy is it to replicate the technology?
The ability of others to copy a technology solution/product is another critical concern for the investor, especially if the competition is well funded. We work on the basis of:
Anybody, with some money and skilled people, can copy anything.
This may sound a little defeatist, but this approach forces us to look at the periphery areas that are more likely to secure the business. But the key is the human aspects. For example, partnerships with other firms and suppliers, especially if the relationships are exclusive. And if there is a key person dependency within the tech team – especially if someone has created proprietary tech, the relationships and ‘flight risk’ post-deal need to be understood and presented as a risk.
From the technology perspective, the time, effort, and knowledge needed to create integrations with others are key – notably, the time it took to learn and perfect connections with others. For example, in one Fintech, it took a couple of years to connect and perfect the messaging between partners, which takes effort and resources from both parties. That situation was almost impossible to recreate by another party.
The CxO’s experience and ability to support intended growth
Investors want a professional opinion regarding the technology leader’s expertise, capability today and ability to support the future business plan. This is a more straightforward judgement if the CxO has previous experience in other PE-backed portfolio companies; even better, we can find evidence of growth in prior companies.
The key to this question is their leadership style, vision and ability to drive the team. Interviewing the team can help bolster the observations, but this depends on who is on the ‘In the Know’ list. Plus, there are many other factors to consider (tenure, skin in the game, and whether the leader is more suited to startup or scale up.
HBR documents some differences in their article How Your Leadership Has to Change as Your Startup Scales. But we often see something in the middle – a technology leader who was excellent at startup and has managed to develop their skills to facilitate scaling the business; yet are no way ready for the pace, expectations and governance that will activate as soon as the deal completes and there are new faces on the board.
In the past 18 months, we have interviewed and assessed many tech leaders who demonstrate high humility – regardless of size, industry and experience. I believe this hints at a key attribute necessary for a firm to succeed and produce the tech that underpins a business that is attractive to Private Equity.
What is decision-making like, and how can it be improved?
Strategy and roadmap are kings – and it’s not unusual for a target’s technology team to be weak even in late-stage businesses with huge revenues generated by the tech platform. So it is critical to provide an opinion on how the technology team has made decisions in the past and how this will impact the spending and business growth. Many firms work on trust and outline plans and do not have the rigour around decision making, spending and return on investment. Especially if this is the first time, the firm will be under the control of an institutional investor.
Whilst the team has always ‘done well’ to get to the stage where they are at the time of the assessment, we need to look at the plans, roadmaps and strategy to see how management made decisions and how value attribution has been identified and tracked. In layman’s terms, is the team identifying what to work on based on customer need and ROI or on what they think should be developed? Has the team any long-term projects that have failed, or worse – tech projects that have succeeded technically but were rejected and not adopted by employees. The ratio of firms with rejected tech initiatives is high and hidden.
What’s the maintenance ratio?
This question will open up a 3D conversation about the overall approach to tech and inform you of the team’s intention. For example, at the time of writing, assessing the level of time, effort and spend spent on tech maintenance (versus net-new activity) has become a common area to consider, regardless of the size or maturity of the business.
Let’s start by saying there’s no ideal or ‘correct’ number here but let us also state that investors want to see the appropriate ratios that match the business growth plan. Unfortunately, we’re finding the ratio is typically out of kilter with the growth plan, which certainly needs to be understood.
What brings this to our attention is when the ratio is unusually low (10-20%) or high (>60%). If the number is high, we need to determine if the number is driven by the CFO (for, say, R&D and capitalisation purposes) or by maybe there are issues with the technology products. If the ratio is low – that could be due to product maturity or possibly to present the team as focused purely on innovation. Of course, there’ll be a different reason and the tech team leadership are the best people to ask, and it’s not to say the ratios are incorrect just that they should be tested and checked.
Do you need a code review?
In most cases, no. At least of the ‘deep scanning’ type where you pay for tools to scan the codebase.
Many investors are keen for that to happen, yet we’ve found that, generally, that code will consistently score an ‘amber’ – it can always be improved. Engaging with code-scanning tools can also significantly add to the cost of the assessment. A cursory browse and review should suffice.
It’s undoubtedly helpful to perform a high-level assessment of the code by checking the repositories. And certainly important to understand the team’s history and to provide an opinion on how well the team have maintained their environment. But of course, you need ‘hands-on’ assessors if you are to rely on consultant’s opinions.
How will it scale?
Sure, the pitch deck or information memorandum will show a growth story, but how will tech support the growth journey and what else needs to be in place to allow that scale to happen? Whilst the cloud provides instant and global scaling of tech products, the tech needs to be designed correctly and use the correct cloud components; otherwise, it can cost you a fortune in the long run.
It’s also common for teams to be aware of cost optimisation opportunities but are too focused on creating new features to spend the time to address the costs. The thinking appears to be ‘when we’ve created more features and added more people; we’ll spend the time scaling the system’. But the problem with that thinking is that they may have to make disruptive changes when there are more users on the system. The changes might be more complicated than anticipated, so I would recommend addressing this quicker.
There is also the general challenge of scaling the tech and operations team when wage inflation and staff attrition are high. Hence, it is essential to understand what those plans are and note if they are appropriate to the firm’s culture and industry. For instance, it’s not worth applying a Fintech hiring strategy to a manufacturing tech solution. As wages, perception and culture will be different and attract another type of staff.
But the most common scaling concern is people – if either professional services or operations teams need to grow as the revenues grow, then we need to question the value the tech provides. And the added burden of increased management and retention needs to be considered.
Other questions to consider during Tech Due Diligence
The great thing about this job is the vast areas that must be considered as a due diligence assessment. It’s fascinating and an honour to be able to access, review and advise on how a technology team provides value today and what the future looks like.
We have hundreds of questions we can ask a target; but here are some high-level themes below:
- What is the size and complexity of the IT estate? – You need to understand what you’re dealing with regarding technical debt, supportability and future commercial risks.
- Who are the critical suppliers, and what is the commercial relationship? – You need to know who keeps the lights on, if there are any contractual risks and how easy it would be to switch.
- How is IT funded, and what’s been done with that money? – You need to understand where the money comes from and where it goes. Matching this information to their financial forecast is also essential to provide insight into the team’s decision-making.
- What is the team culture like, and how does it impact delivery? – You need to know if the team are all working towards the same goal and that they have the right skill set to achieve it.
- How mature are their processes, and what does this mean for you? – You need to understand how well the team works together and what kind of processes drive the team’s output?
- What are the risks, and how are they being managed? – You need to identify potential risks that could impact the project’s success and understand how they are managed.
- What is their governance model? – You need to know who makes decisions about the project and how those decisions are made. Knowing this will help you understand the team’s decision-making.
- Cyber is, of course, a vast topic. So how are they managing it? – With all the news about data breaches, you need to understand how the team manages cyber security risks.
Tech Due Diligence is an art.
You need a clear management report that articulates the risks and highlights potential opportunities. Yet Tech Due Diligence is a growing field but one that is not without its challenges. Because it’s essential to collect the correct information and facts and provide a professional, balanced and insightful opinion across a business. The ‘art’ here is asking the right questions that are pertinent to the situation and of value to the investor.
If you’re interested in learning about technology due diligence, check out our whitepaper “Five questions EVERY investor should ask about technology“. This paper will provide you with the standard questions we typically see investors asking and five questions that may be insightful during a deal’s early processes.