What Is Technology Due Diligence?

Technology Due Diligence

Technology due diligence is the process of assessing and analysing the technology, process and people within a company as part of the acquisition of or investment in it. This provides the acquirer or investor with details of potential areas of downside risk and hidden opportunities to create value before committing to the transaction.

But what exactly is it?

Consider the process of buying a new home. You would not buy a house, nor would you be able to obtain the necessary finance, without the property first being inspected by a professional surveyor. The cost of the survey is negligible when compared to the total cost of the house purchase and provides the purchaser with confidence in the house being fit for purpose. In some cases, it enables the purchase price to be adjusted to factor in remedial work that is required.

When considering the purchase of a company, technology due diligence enables an investor to gain an understanding of the technology areas of the business before committing to the transaction. In particular, downside risks and threats to their investment thesis and hidden opportunities to create value or to reduce the cost of creating value that has not already been disclosed.

The technology areas will include not just the software and systems but also the operational processes and people required to support the future business growth strategy such as product and software development. An investor may also be interested in the defensibility and differentiation of the technology, such as the barriers to a new entrant disrupting their current business model. More recently, additional areas of focus have become of greater importance due to their potential impact in the digital age.

The output of technology due diligence is typically a report that allows the investor to be fully aware of the risks and weaknesses of areas of concern and the potential costs required to complete any remedial actions. Technology due diligence is typically performed alongside other areas of due diligence such as commercial, legal and financial.

Technology vs IT Due Diligence

Technology and IT are terms often used interchangeably. With regard to due diligence, they are complementary but different. Technology due diligence covers technology as a whole to encapsulate the technology, processes and people that are in place to support or lead the business, including external-facing websites and apps and internal-facing tools and applications. IT due diligence tends to focus purely on internal IT such as back-office systems, networks and applications.

The rapid evolution of technology has dramatically changed how people and businesses do things. Almost every activity performed in the last 5 years has changed including shopping, banking, reading, listening, exercising, relaxing and almost any other verb you can think of. Technology, and/or IT, has reinvented how these activities are now performed whether at home, on the beach, in the air or in day-to-day working life. The disruption caused by start-ups and megatrends now means that the due diligence process must be rapid and relevant whether it is called technology or IT.

Technology Due Diligence Process

Before beginning the due diligence process the scope of the engagement must be agreed. For buy-side transactions, this will include the investment thesis of the buyer. For sell-side transactions, this will include the key areas that are to be part of an investment memorandum. The scope should be broken down to appropriate areas of focus that logically fit together to provide a holistic view. For example, security should be a distinct area rather than reported upon in individual areas. Areas such as architecture, infrastructure, databases, e-commerce, software development processes, applications, products, staff, operational practices and a host of others may be assessed for suitability and fitness for purpose. Each of these areas should have specific questions that require answers.

Once the scope and area of focus have been agreed, a trusted relationship and dialogue must be formed with the target. The relationship must balance formality with informality, and neither an inquisition or form of therapy. An approach that is too formal can lead to disaster in competitive situations, with a target company deciding the acquirer is simply not one they wish to do business with. Being too informal can result in details being missed and situations being glossed over.

Checklists

Firms may follow a technology due diligence checklist. Although these form a useful bounding box to frame the engagement, they have lost their usefulness in recent times. Technology due diligence is now no longer an exercise to report on what exists. The digital age has enabled anyone to create a successful business with a credit card and access to online technology learning platforms. The plethora of different technologies available has made the judgement on whether A is better than B all the more difficult. Every company is at a different stage on a different journey to a different destination. As such, checklists must be tailored to the individual needs of the situation, rather than simply reused from engagement to engagement. Additionally, visual contact with the business that is being assessed is imperative to obtaining a rounded opinion. Anyone can tick a box or write down the words required to pass a simple binary check. When a verbal and visual discussion enables non-verbal signals and cues to be observed, and actual evidence to be witnesses. For example, anyone can say that their software development processes follow an agile approach, but is this actually the situation in reality? Are cloud services really deployed? In both examples, actually seeing the software development working areas and supervised inspection of tools provided by the cloud providers can enable written and spoken words to be verified.

Analysis and Report

The analysis of findings and observations should be complemented with research and analysis of external factors. This is not necessarily a review of what other similar companies are doing, especially if the opportunity exists for the company to gain a competitive advantage by following a different path. What works for one company, even if that is the dominant company, does not necessarily mean it is the right for the company being assessed. The findings should be reported in an easy-to-read format but include the required detail. The audience of a technical due diligence report will vary, from those with very little technical knowledge to others that may be technically proficient. Finding the balance is crucial.

Can a potential acquirer perform technology due diligence of a target business themselves? A trusted third-party can provide an independent and objective view derived from a team that has the specialist expertise required. They also have the ability to provide relevant insights into how technology and digital trends may disrupt or provide opportunities that have otherwise not been considered. Using in-house internal resources can result in a costly and subjective result, as resources are taken away from their day-to-day role and have an opinion that is best for them rather than the company.

Whether you are a Private Equity firm, an investment bank or a company looking to make a strategic acquisition, Momentum can provide you with a rapid and truly independent technology due diligence analysis and report that focuses on the matters that are material to the investment decision. Contact us for a confidential conversation specific to your situation.