Updated: Aug 16
Technology was at one point the maidservant providing advantages for business, but it's increasingly becoming the master. The speed of technology today is enabling new business models, creating new markets, and disrupting established products faster than even the most optimistic predictions.
Due diligence exercises are also evolving to accommodate those changes. The reality is investors are buying the past, present, and future, and the latter comes faster today than it used to be due to the speed of technology.
However, if we try to look for consistency or coordination in how diligence is executed today, we’re in for a big disappointment. Due diligence 2.0 requires all types of diligence, such as commercial, technical, and legal, to adapt and collaborate, feeding into one another.
The era of siloed diligence that is looking at distinct areas is no more. Also, the era of bundled one-stop shop diligence for a price advantage is quickly coming to an end.
Download our 2021 technical due diligence all-you-need-to-know definitive guide.
State of Due Diligence Streams
Commercial diligence has somewhat adapted to new business models created by technology in recent years. However, they still lack strong coordination with technology diligence. Commercial diligence that does not take into consideration how technology may impact the market or product is not delivering a full picture accurately. As an example, an absolute TAM (total addressable market) is not as real as one that is qualified with the technological state and capabilities of a target.
Legal diligence had a less urgent need to adapt and remained fairly static with a few nuances, such as intellectual property concept shifts (e.g., data as an IP), the need to keep up with evolving regulations, and more globalized patent and taxation challenges.
Investors have had also to adapt and acquire an understanding of technology and the IT landscape to help them make sound investments.
The tech due diligence offering has largely remained the same even though it has become the primary driving force that makes or breaks investments.
Tech Due Diligence History
During the 1990s, technology was just beginning its disruptive journey as an “enabler”. Historically, in the 1990s, technology due diligence was hardly executed or was extremely casual. In the 2000s, it was very much of a tick-the-box exercise executed opportunistically. It wasn’t until the 2010s that technology due diligence solidified its position as a core offering. But even then, it remained separate from other streams and often had a minor impact on the go/no-go decision.
A large segment of technology due diligence providers have flourished over the years but remained vastly fragmented without set standards or a common playbook. Today, technology due diligence is provided by one-man bands, small consultancies, or bundled with large consultancies' other offerings.
In summary, technology due diligence has primarily addressed the famous “Is the technology sound?” question and is somewhat engineered to complement deals that are nearly sealed or may have already happened.
What is Tech Due Diligence 2.0?
Today, technology is undoubtedly in the driver’s seat. Most businesses today are either technology companies or fully technology-enabled in one form or another, with an acute impact on the EBITDA and investment exit multiples.
Tech due diligence is nevertheless in dire need of a refresh. The archaic, fragmented, and non-standardized formats are no longer suitable for the purpose, given the impact of technology on the business today (see Technology is shifting the risk profiles for private equity).
Tech Due Diligence 2.0 takes a more strategic 360 holistic approach that feeds and collaborates with other streams for better outcomes and risk reduction. The focus shifted to include risks impacting the “future” EBITDA and “technology suitability” to accomplish and exceed the investment thesis while avoiding any potential seen or hidden landmines.
One of the biggest challenges we’ve heard from GPs over the years is the ability to get consistent and quantifiable data on technology that helps compare apples-to-apples across potential or existing investments to be able to make business decisions.
Diligence 2.0 is data-driven, with quantifiable data and KPIs that feed into the value creation cycle to maximum benefits.
Strategically, it seeks to fully understand the investment thesis with a crisp focus on determining the suitability of technology and its ability to evolve to accommodate the business strategy and faster technology changes.
For example, a conclusion in traditional technical due diligence may be that the product is healthy and the technology choices are sound while identifying some risks to be mitigated. This is not enough value these days!
A due diligence 2.0 would seek to understand the flexibility of the technology and its ability to evolve if the market shifts. It would explore specific data points about how long it would take to mitigate and how to achieve investment. It would explore reasons why technology may be disrupted and how to avoid it. The diligence would provide opportunities for a greater return on investment with new deployment models or architectures which should be explored and certainly may affect the commercial stream. Modern due diligence would surface EBITDA advantages and alternatives.
A Technology diligence 2.0 would help investors determine the past and present states but would also explore and shed light on the role of technology in helping explore the future state and possibilities. This can be in the ability to create customer value, enter new markets, grow existing market shares, improve quality, improve time to market, optimize costs, or improve the brand by reducing compliance and security gaps.
The due diligence conclusion must take into account the investor strategy, management style, portfolio status, and risk tolerance. It’s a much deeper relationship than a one-time superficial hire could offer.
It’s precisely what is needed to minimize the growing risk in product and market driven by technology in private equity investments. It is also what makes the difference between the 2x and 4x exit multiples spread providing an advantage.
In our experience working with General Partners over the years and the evolving technology due to the diligence landscape, here are the Best 7 considerations when selecting diligence providers.
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About the Author
Hazem has been in the software and M&A industry for more than 26 years. As a managing partner at RingStone, he works with private equity firms globally in an advisory capacity. Before RingStone, Hazem built and managed a global consultancy, coached high-profile executives, and conducted technical due diligence on hundreds of deals and transformation strategies. He spent 18 years at Microsoft in software development, incubations, M&A, and cross-company transformation initiatives. Before Microsoft, Hazem built several businesses with successful exits, namely in e-commerce, software, hospitality, and manufacturing. A multidisciplinary background in computer engineering, biological sciences, and business with a career spanning a global stage in the US, UK, and broadly across Europe, Russia, and Africa. He is a sought-after public speaker and mentor in software, M&A, innovation, and transformations. Contact Hazem at firstname.lastname@example.org.