Technical due diligence is a part of several types of high-stakes transactions involving technology companies. Other types of diligence include legal, financial, and team diligence. Interestingly, different types of transactions tend to lean on different types of diligence processes, even though technical issues can pose just as great a danger to a technology venture as legal, financial, and team issues. In this post, we review the ways in which different industries view technology due diligence and also look at why and how technical due diligence should be done.
Due Diligence in Venture Capital
In venture capital, where VC funds deploy many millions of dollars into early-stage and growth-stage companies, technical due diligence is often not an integral part of the diligence process. At the earliest stages of a startup where there is not much in terms of technical implementation, the lack of a formal technology evaluation is understandable. Also, when check sizes are small (mostly the case with angel investors), paying tens of thousands of dollars on technical due diligence may not make sense.
In cases where a VC fund deploys millions of dollars per transaction, technical diligence should really be a part of the investment process. However, a thorough technical evaluation is usually still omitted. Some funds have technical experts in-house that can quickly glance at the technology stack or evaluate the critical parts of the technical innovation. Unfortunately, the speed at which the venture capital transactions are conducted does not often permit a thorough technical review. And since nobody does it, this is the de facto industry practice.
Due Diligence for Mergers and Acquisitions
Contrary to common practice in venture capital, technical due diligence is industry standard for M&A transactions. Perhaps due to the higher ticket size of these transactions and the fact that acquiring companies run the process through corporate development teams with well-established processes, technical due diligence is often a required box to check.
For M&A transactions the question is more about whether to outsource the technology due diligence function or conduct it using in-house talent. When a company to be acquired is to be closely integrated with an existing business unit, it is highly recommended to have the company evaluated by the acquiring business unit. The problem is that the acquisition target company should not trust their highly confidential technology to outside entities that may copy their intellectual property.
A best practice for M&A transactions is to hire outside consultants who specialize in performing technical due diligence according to a time-tested formula and can do it efficiently on a tight schedule. Consultants also have confidentiality obligations that protect the acquisition target from needlessly disclosing their intellectual property in case the transaction falls through.
What to Look for in Technology Due Diligence
For executives, it can be challenging to see what’s the important aspects of technology due diligence are. Most importantly, software stacks must be evaluated for their business impact. Any aspect of source code, open-source libraries, and infrastructure components must be evaluated to minimize the risk of a business impact.
Source code must be architected expertly for maintainability, extensibility, and scalability. Unfortunately, code quality can only be evaluated by experts’ eyes, and not by any automated method. Similarly, any machine learning technology in use in the software stack must be appropriate for the task and must scale with the product in which it is deployed.
Programming languages should be selected for the particular type of product, its popularity, and community support. Infrastructure components must be robust and expertly configured for scalability and easy maintenance.
Software engineering is an engineering discipline like any other, and it requires well-oiled processes supported by developer operations tools, such as issue tracking, documentation wikis, code repositories, continuous deployment, etc.
At Sidespin Group, our experts can help with technical due diligence for investment, mergers and acquisitions, and technology transformation / restructuring. Our experts have worked on M&A transactions and technology transformation projects involving the biggest industry names, such as Berkshire Hathaway and WordPress.