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@Scale – Tech Due Diligence: Essential Success Factors

Tech DD Failed Idea Resolved-min

As one investor told me early on my journey working with Private Equity, “we don’t like lumpy projects“. He then described a painful situation where an unexpected and costly IT product upgrade destroyed a portfolio firm’s value / projected growth.

Probably not the exact words he used, but you get the picture.

At the time, it was evident that tech was a utility to PE firms. It should just work. That was years ago; nowadays, technology is often critical to business growth, and some form of supporting tech usually boosts the bottom line.

Tech due diligence is required to ensure the underlying tech is sound & also to try and mitigate the investors from any nasty surprises. That’s common sense.

But also essential to see what needs to be typically in place for a deal to go smoothly (from a tech perspective) and then share what we tend to see when first assessing companies.   From those two vantage points, you’ll be able to see the gaps between the two and start addressing obvious issues quicker.

The three critical success factors

Due diligence is a complex case of “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, none of which would exist without the team that creates and maintains it.   It’s usually relatively easy for us to get a sense of the team’s capabilities and history and marry the two to understand how the team will succeed in the future.

2. Tech supports growth plan.

Investors want to know if the team can deliver against promises and whether any improvements are ‘real’ and appropriate for the platform.

In simplistic terms, this is a case of bringing together ‘investor’s assumptions’ with the ‘tech team’s roadmap’ and seeing how this supports scaling the business. As stated to investors, is technology beneficial to the company, and is the strategy realistic and fit for growth? Note ‘commercial due diligence would also assist here, ensuring existing and new customers would be interested in any new ideas on the horizon.

3. Minimal Tech Debt 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.

As more investors are starting to use tech due diligence, we see more are aware of the term technology 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:

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 need to be able to dig deep into your environment and then resurface with summarised conclusions that are easy for non-tech people to understand.

Instead, what we tend to see during Tech Due Diligence

You won’t be surprised to see that the typical concerns we tend to see during Tech Due Diligence are the polar opposite of the investors’ requirements.

A. The team needs some changes or support.

What got you here, won’t get you there.

The severity and need to adapt are related to your business’s maturity and what has been promised in the business growth plan.

This will vary from business to business, but additional help is required to enable the technology team to deliver against the growth plan. It can be as simple as other hires that you’ve already had marked down in your plan, but more often than not, there will be some adjustment to working in the ‘new world’, which means better communication and documentation.

So this may manifest in some extra accountability, technical assistance or coaching to help you and your team communicate with the new board. In other cases, the entire target operating model needs re-defining, which can be pretty gruesome for the tech 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 or customer need. And Tech isn’t always the enabler of growth as per this Pew Centre article.

Examples of this concern found during Tech Due Diligence follow:

  • Poor data management means scaling the firm will become a more significant business liability. Whilst the firm is ‘small’, this isn’t an issue, but this is a major red flag as soon as it grows.
  • Want to move from SMB to Enterprise or vice versa. Excellent in principle, but they are often different business models.
  • Wanting to externalise internal products. Again a different business model and lack of focus.
  • Different tech stacks across other regions. A historical concern that raises its nasty price tag today.

There are so many unique examples of this. But the good news is that Tech Due Diligence is the opportunity to raise your known concerns so that ample budget can be put aside to address them (if it makes business sense).

C. Tech Debt, Risks and Liabilities

Liabilities can be simple contractual concerns. Or configuration issues – for example, we had a situation where a contractor had been ‘utilised’ to configure a rapid cloud version of a product, and it was working. 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 that saving per year equates to £2m saving at the time of selling the business. We operate on a simple ’10x’ multiplier when making similar assessments.

Another common area is software licenses – which has been agreed to previously. 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.

Of course, there is information data, how was it gathered, and how is it secured.

To conclude

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 plan is produced to fix it.

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Hutton Henry
Hutton Henry
Hutton's technology industry experience spans Enterprise (Ford, HP etc.) to start-up ventures. 25-years post-merger technology integration experience, and small consultancy founder since 2010. He is currently the founder of Beyond M&A, where he has the privilege of working with VC and PE investors, translating how tech operates in their future investments and identifying additional value creation improvements.

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