Updated: Aug 16
Are you a target getting ready for tech due diligence?
The preparation as well as the process can be daunting and require a fair amount of preparation and time. However, given an ample opportunity to prepare and knowing what to focus on, will be tremendously helpful.
Tech due diligence is to some extent a test, but don’t take it personally. They are not there to judge you. It’s an exercise to measure the probability of the investor being able to achieve their business goal and investment thesis. It’s about risk elimination and mitigation, but it’s not about how perfect your product or service is.
When an investor steps in, you are inviting someone to be a partner even if they are a minority shareholder. Ultimately, they have a plan in their mind that helps them realize gains. The days of an investor showing up with a bag full of money and letting you run with things are rare nowadays. At the end of the day, their goal is to validate and gain confidence in their plan and your ability to get there.
In competitive situations where there are multiple bidders, you might be able to get away with less, but you also owe it to yourself to find the best marriage possible and the highest bidder, so you best do the homework and prepare for the occasion. In some ways, the buy-side diligence exercise is also a great opportunity to exercise for future sell-side exit diligence. Going through it again in the future will be easier.
Depending on whether it is a private or growth equity deal or corporate M&A, there are dozens of investment strategies that range from acquiring just intellectual property, talent or technologies, or the whole. But for the sake of this article, we will focus on the most common one related to a standard growth investment strategy with an average 4-6 years hold-period, which in some cases is designed to help you add some value to grow, and then an eventual sale. It’s analogous to buying shares in a publicly listed company after you have done some research and then selling it to realize a profit.
It’s good to understand the style and approach of the particular investor of course, but also broadly the risk profiles for the class of investors to be able to deliver to them what they need. This is especially true if the management team are the original entrepreneurs who established the business. The mindsets are generally different between investors and entrepreneurs.
Tech Due Diligence Checklists
There are two core checklists for tech due diligence. The first is a 10,000-foot investment-focused checklist which is a critical first step to understand the rationale of the investment.
The second is an in-depth tech due diligence checklist provided in part 2 of this article to help prepare for the nitty-gritty.
Investor Focused Checklist #1
The first checklist focuses on understanding the investor’s mindset to be better prepared. It comprises these core five areas based on value creation levers, but not limited only to those.
Understand the strengths, weaknesses, and gaps in the product or service compared to the competition and the ability to capture revenue quicker
Understand the architecture and infrastructure suitability and ability to evolve to:
Accommodate potential expansion in existing markets or new markets
Improve the product or service features and quality to add customer value
Have the ability to pivot under competitive threat or market shifts
Eliminate potential hidden surprises that could interfere with revenue generation or require major additional and distracting investments such as security gaps, unmanaged technical debt, vulnerabilities, or business continuity issues
Gain trust in the leadership and team to execute and deliver including attracting and retaining talent to execute on the roadmap with a reasonable and optimized cost
Test the thesis to make sure that the investment is solid and evaluate other strengths to improve or extend the thesis ultimately evaluating how much are you worth
Company Focused Checklist #2
Part two of this article expands on what you must cover from a company perspective in order to best be prepared. You will need to cover the relevant areas below in depth.
Fortune does favor the prepared! The in-depth technical due diligence areas and related questions would help you prepare for successful diligence and make the process easier for everyone involved.
Technical Due Diligence Best Practices
Do be familiar with the Information Memorandum if one exists to be able to answer questions
Do grasp as much depth as possible about the investment thesis and exit strategy
Do prepare to answer questions about the past, present, and future
Do prepare to host the diligence team and investors in person and remotely
Do prefer face to face interaction vs remote when possible
Do review the agenda and be clear on who will be available in each session
Do agree on roles and responsibilities among the team before the sessions
Do prepare presentation materials and rehearse ahead of time
Do prepare to show and tell internal documents, architecture flow diagrams, backlog, and roadmaps
Do be open and forthcoming about areas of development and weaknesses
Do prepare to whiteboard whether in person or remotely to bring clarity when needed
Do propose agenda items for potential gaps that help place your company in a positive light
Do relate answers to questions with an investor hat on (see investor checklist)
Do support answers to questions with documentation and data
Do coordinate well and avoid interrupting your colleagues to avoid showing a lack of preparation, communication, and clear ownership
Don’t hold back covering areas not included especially strengths about the company or products
Don’t be defensive or pick a fight when difficult questions arise; the intentions are always good and the likelihood is that others are just trying to understand
Don’t oversell and make things look too good. No one has perfect architecture or no technical debt. Present a realistic picture of the current state and the desired future state - it shows leadership
Don’t use fancy buzz words like AI or ML to unnecessarily magnify simple things just to look good. People will see right through that
Don’t neglect to coordinate with other functions; lack of alignment can be detrimental
Don’t overemphasize code reviews or spend too much time on that; code is important but only to a certain level. Tech due diligence is not about looking at every line of code
Your ultimate goal during a tech due diligence is to be able to zoom in and out as needed during the sessions, be ready to dive into the nitty-gritty, use demos, whiteboarding, and show what’s under the hood while presenting a comprehensive, consistent, and clear picture.
In summary, use the tech due diligence Investor Focused Checklist #1 to prepare your strategy for the diligence, focus areas, and understanding how to approach it like an investor.
In the second part, you leverage the Company Focused Checklist #2 to help you cover all of the potential areas that you need to be prepared for.
The Dos and Don’ts will help you focus on how to drive successful diligence sessions while keeping the focus on what’s important.
Download our 2021 technical due diligence all-you-need-to-know definitive guide. This guide will help you explore the best technical due diligence questions to explore.
Other great resources for preparation include the Synopsys and WhiteSource guides. Honorary mentions include Cast, TMS, and the largest tech due diligence liabilities from PEHub, recent trends showing that greater than 50% of acquisitions fail to deliver on the expected return on investment from Forbes, and the evaluation of the risks from the Washington Post.
About Agu Aarna
Agu has been involved in the software development industry in every conceivable way, being a developer, architect, and CTO while also staying active in the M&A industry. He has seen software and IT inside and out.
He is a founding partner at RingStone working with private equity firms and portfolio companies in an advisory and operating capacity. Agu is responsible for building tech due diligence practice and strategy and coaching CTO consultants globally.
Agu is an engineer at heart, with a strong technical background and deep experience within modern technology, software development, and product management. He has facilitated and executed numerous organizational transformations, groomed organizations, architectures, and teams during high growth stages to sustain rapid expansion, successfully driven innovation, and migrations to the cloud unlocking high data load potential and economies at scale. Contact Agu at firstname.lastname@example.org