Early on my journey working with Private Equity, an investor told me, “we don’t like lumpy projects“. It’s a good guide for Tech Due Diligence projects. Investors don’t like expensive surprises.
He then described a painful situation where an unexpected and costly IT product upgrade. The additional expense seriously impacted the value at the next exit.
Technology is often critical to business growth, and some form of supporting tech usually boosts the bottom line. Hence, Tech due diligence is required to ensure the underlying tech is sound & also to try and protect the investors from any nasty surprises.
So, I share the high-level success factors that must be in place for Tech Due Diligence to go well; and the best outcome for the business seeking investment and the investor.
The three critical success factors
Tech Due diligence is often akin to “investigative journalism” researching competing stories across an entire business and management team. So it would seem impossible to boil this complexity down to three main objectives.
But investors are not looking for complexity. Instead, they are seeking a straightforward narrative that begins with the following three areas:
1. Investible tech management and team.
A high-performing team with a positive and productive culture wins. Tech Due Diligence is an opportunity to assess an entire tech environment, including the team.
It’s usually relatively easy for us to understand the team’s capabilities and history. Then marry up the two to extrapolate how the team will succeed in the future.
What does ‘investible’ mean? We would assume the team is technically capable of building and supporting software but can they (a) increase their commercial focus and (b) adapt to managing faster-paced projects, with high levels of governance?
2. Technology strategy aligns with the business growth plan.
Investors want to understand how the technology strategy will perform and support the growth projections.
This also depends on how much technology innovation is core to the company’s growth,
This simply means comparing the investor’s investment thesis and assumptions with the tech team’s strategy.
Some judgement will also be made regarding the value of technology. E.g. is technology beneficial to the company, and is the strategy realistic and fit for growth?
Key to the growth plan is both a historical record and the forecast IT Budget; the details of what is needed during IT Due Diligence are in this article What goes in an IT budget for Tech DD?, especially for software-focused tech due diligence.
Note that commercial due diligence is also an essential cross-reference. We need to map the technology offering against commercial and market opportunities.
3. Minimal Tech Debt and Post-Deal Liabilities
What will the investor be liable for after the deal completes? The investor wants to know what financial risks there are in the environment. This can be uncovered by looking at the technology architecture and platform alongside any vendor agreements you have in place.
How much of an investor’s money will go towards fixing issues or maintaining systems (versus real innovation?)
As more investors are starting to use tech due diligence, we see more are aware of the term technical debt. Not surprisingly, as it has a name that links to their financial background, it’s of great interest.
For those interested to know more about Technology Debt beyond a glossy consultancy paper, Adam Tornhill‘s primer is helpful to think about quantifying the ‘cost’ of tech debt:
One last word on these essential factors
These high-level requirements might seem simple compared to the complex, inter-related tech environment you’ve built and continue to maintain.
But that’s the point. We dig deep into your environment and provide summarised findings in a way that’s easier for investors to understand. In effect, we act as translators.
You can also find an overview of investors’ Tech Due Diligence requirements in this article, Tech DD – What Do Investors Want?
Instead, what we tend to see during Tech Due Diligence
Yet, most tech environments we review during Tech Due Diligence are the polar opposite to the success factor listed above.
A. The tech team needs to change.
Instead of ready-to-go management and technical team, there are gaps and issues.
Typically there are skills gaps. Additional help is required to enable the technology team to deliver against the growth plan.
What got you here, won’t get you there.
Your business’s maturity will have a bearing on the investment needed to rectify issues within the tech team.
The changes in your hiring plan may be simple. Such as adding a couple of more heads or hiring fractional skills. But more often than not, there will be some adjustment to how the team operates post-deal.
So this may manifest in some extra accountability, technical assistance or coaching. The CTO may need help communicating with the new board.
In the most complex cases, the entire target operating model needs re-defining. Which can be pretty gruesome for the leadership team.
B. Tech is a hindrance to the growth plan.
Some management teams can be pretty frustrated as their businesses’ technology cannot adapt quickly enough for their business. And Tech isn’t always the enabler of growth, as Tech can cause more problems than it solves.
Examples of this concern found during Tech Due Diligence follow:
- Poor data management and cyber security. Whilst the firm is ‘private’ this isn’t an issue but post-deal, this issue is a liability for the investor.
- Poor or uncertain business strategy. Want to service SMB to Enterprise or vice versa? Excellent in principle, but they are often different business models.
- Lucky first time but not the second time around. For instance, wanting to turn successful internal service-oriented software into SaaS. Typically this is a different business model and demonstrates a lack of focus.
- Tech Sprawl/difficult to adapt. Different tech stacks across regions. A historical strategy that fixes problems quickly in the short term but has a nasty price tag in the future.
There are so many unique examples of where tech is the ‘problem’.
But the good news is that Tech Due Diligence is the opportunity to raise your known concerns. Often bringing some of these issues to the board table for the first time. This allows debate, resolution and resources to put these issue(s) to bed.
C. Considerable Tech Debt, Risks and Liabilities
Liabilities can be simple contractual concerns. Or technical burdens. For example, we had a situation where a contractor had configured several small firms’ cloud environments. Whilst the products were operational, the costs were not optimised.
But the contractor left, and the firm was overspending by £200k per year. However, the profits of the firm made this figure negligible.
But note that an investor thinks in ‘future multiples’. So we tend to ’10x’ any cost savings to provide an indicative benefit at exit. In this case, the annual saving equals a theoretical £2m impact on the businesses at exit.
Another common area is third-party software licenses.
- There used to be a typical behaviour where teams paid for lower-tier licenses but used the higher-tier product. So in effect, they are unlicensed, and a remediation plan is needed.
- Or for SaaS products, we often meet teams who have oversold a product or features they don’t need. In this situation, some expertise is needed to correctly remove the costs.
Of course, there is information data, how it was gathered, and how it is secured.
Tech Due Diligence is easier if you prepare for it
Tech Due Diligence is more than an ‘audit’. It’s a professional assessment that helps technology leaders plan for the next growth stage.
The ideal outcome is to ensure the tech environment ticks the three success factors above. But if it doesn’t (which is more likely), a clear understanding of the plan and associated costs are presented.
It’s also worth considering that the type of buyer will impact the level of IT Due Diligence and the key questions Critical Questions to Ask during Private Equity Technology Due Diligence.