Technical Due Diligence: A Comprehensive Guide to Ensuring Success

The technical due diligence process should be carried out thoroughly if you want to invest in a startup or buy a business. Technical due diligence is a thorough check of a business’s IT infrastructure, code quality, decision-making process, and possible risks. This process helps investors and buyers figure out what a product’s pros and cons are, how much it’s really worth, and make smart choices. This blog post will talk about what technical due diligence is, how it works, and what it includes on a plan. It will also include tips for doing a good audit.

Technical Due Diligence: A First Look

Technical due diligence is the process of investigating and evaluating the technology assets and operations of a company prior to an acquisition, investment, or other major business transaction. It serves several important purposes:

  • Provides a comprehensive assessment of the target company’s technology infrastructure, systems, intellectual property, capabilities, and risks. This informs the valuation of the deal.
  • Identifies any technology issues or vulnerabilities that could impact the success of the post-acquisition integration. These need to be addressed during the transition process.
  • Finds technological advantages and innovations that offer a competitive advantage and have high strategic value; recommends these for investment and use after the sale closes.
  • Enables the purchaser to strategically anticipate the technological requirements of the target company’s future, including investments, resources, and adaptations.
  • Ascertains that vendor and provider technology contracts are transferable and beneficial.

In the realm of investment rounds and merger and acquisition (M&A) deals, a crucial step that typically occurs after the initial proposal but before finalization is the implementation of technical due diligence. The methodology assesses the operational processes, systems, data resources, security protocols, contractual agreements with suppliers, personnel, and intellectual property of the target organization.

Assessing risks, verifying valuations, preventing unforeseen issues, and providing proactive planning for technology integration challenges are the key objectives of technical due diligence. To minimize interruption and enable a smooth transition following the acquisition, thorough technical due diligence must be conducted. It gives the buyer a detailed and accurate picture of the technology that they are buying.

Technical Due Diligence

Key Steps in Technical Due Diligence

Thoroughly preparing for technical due diligence involves careful and detailed planning. Outlined below are several crucial protocols:

Making Due diligence team

  • Hire specialists that possess specialized knowledge in the fields of information technology, engineering, operations, legal, and finance.
  • Convene a collective of individuals to evaluate your organization.
  • Consult with external specialists to guarantee impartiality.
  • Designate a project manager to supervise the involvement of the team and external specialists.

Defining the scope

  • Determine the IT systems, products, IP, and operations to be assessed. Prioritize areas with the highest risk.
  • Outline the diligence process, requirements, and goals. Focus on deal-critical issues and key decisions.
  • Develop specific diligence topics and questions to guide the evaluation.

Setting timeline and budget

  • Allow enough time for thorough diligence across multiple functional areas. Complex deals require more time.
  • Build in flexibility for unforeseen delays. Pace activities based on target company responsiveness.
  • Define budget for external advisors, travel and expenses. Allocate resources across diligence workstreams.

Gathering necessary documentation

  • Create a data room with licenses, contracts, financials, product specs, architecture diagrams, code, etc.
  • Request additional details from target company to fill information gaps. Sign NDAs if required.
  • Organize materials into folders by topic for easy access by diligence team members.
  • With careful planning and a well-assembled team, you can conduct effective technical due diligence and avoid costly surprises. Defining the scope and timeline ensures the evaluation stays focused and on track.

Technical Necessities Evaluation in Acquisitions

  • Acquirers conduct technical examinations of target company’s IT infrastructure.
  • Insights include quality, security, scalability, and overall technology health.

Assessing Technology Infrastructure

  • Understanding the complete structure and arrangement of systems.
  • Examining the used technology stack and essential software platforms.
  • Examining interconnection and interdependence of systems.
  • Ensuring architecture exhibits modularity, extension, and adaptability.
  • Identifying high-risk or outdated technologies, integration challenges, vendor lock-in risks, and architecture constraints.

Evaluating Code Standard

  • Assessing software development guidelines, coding standards, conventions, and documentation.
  • Evaluating modularity, reusability, and complexity in coding.
  • Evaluating test coverage and automated processes.
  • Enhancing maintainability and extensibility.
  • Improving coding methods to reduce technical debt, maintenance costs, and risk.

Evaluating Security

Security is perhaps the most critical element to assess. The review identifies vulnerabilities and gaps across:

  • Network, endpoint, application, and data security
  • Access controls, encryption, and key management
  • Security policies, procedures, and controls
  • Incident response and disaster recovery preparedness

Understanding the security posture is essential to properly evaluate risk and determine the incremental investment required.

Analyzing Scalability

Reviewing capacity plans, load testing, infrastructure, and architecture design reveals the system’s ability to scale. Key areas to examine include:

  • Forecasting models and growth assumptions
  • Infrastructure sizing, utilization, and flexibility
  • Caching, databases, and potential bottlenecks
  • Peak load performance and stress testing

This helps identify scale and performance risks that could impact user experience and system stability under peak growth.

Identifying Technical Risks and Issues

The technical assessment consolidates findings across architecture, code, security, and scalability to highlight key issues and risks. This provides data to estimate potential remediation costs and inform the deal negotiation.

With comprehensive technical diligence, acquirers gain crucial insights to evaluate the true health and value of the target’s technology. Identifying risks upfront ensures there are no costly surprises down the road.

Examining Intellectual Property

Intellectual property (IP) is a critical area to examine during technical due diligence. The acquirer will want to fully understand the target company’s IP assets, obligations, and potential risks. 

Reviewing Patents, Trademarks, Copyrights

  • Compile a list of all patents, trademarks, copyrights and other IP registered or applied for by the target company. Review priority dates, expiration dates, jurisdictions covered, and ownership.
  • Assess the strength and strategic value of key IP assets. Which ones offer competitive advantages or future opportunities?
  • Look for pending applications or lapsed registrations that could impact value.
  • Consider if any IP could be invalid or unenforceable. Analyze prior art and freedom-to-operate risks.

Identifying Licensing Agreements 

  • Review all licensing, technology transfer, and IP-related agreements.
  • Determine if the target company licenses IP from third parties. Analyze any royalty payments or other obligations.
  • Assess if the target company licenses or sells its IP to others. Understand revenue streams and obligations.
  • Consider termination clauses, transferability, and other contract terms that could impact the deal.

Assessing Potential IP Issues or Risks

  • Look for signs of prior IP disputes or allegations of infringement.
  • Research whether any of the target company’s IP overlaps with competitor patents or poses other risks.
  • Assess strength of trade secrets and know-how documentation to protect confidential information.
  • Determine if any IP is subject to security interests or other encumbrances.
  • Consider jurisdiction-specific laws that could influence IP rights transferability.

Proper IP due diligence mitigates risks, validates deal value, and ensures the acquirer understands what they are purchasing, allowing for a smooth post-acquisition integration.

Evaluating Technology Operations 

A critical part of technical due diligence is evaluating a company’s technology operations. This involves assessing the systems, processes, infrastructure, and plans that keep technology running smoothly. Key areas to review include:

Reviewing development processes

  • What SDLC methodology does the company follow (e.g. Agile, Waterfall)? Is it documented?
  • How are requirements gathered and prioritized?
  • What does the design/development process look like?
  • How is testing and QA handled?
  • How are bugs tracked and resolved?
  • How is the deployment/release process managed?

Analyzing quality assurance

  • Is there a dedicated QA team and process?
  • What types of testing are performed (unit, integration, system, smoke, etc)?
  • Are there documented test plans, test cases, and expected results?
  • How much test automation is there?
  • How are regressions avoided across releases?
  • What key quality metrics are tracked (defect density, open bugs, etc)?

Assessing release management

  • How frequently are releases done?
  • Is there a release schedule or roadmap?
  • What does the build, staging, and deployment process look like?
  • How are rollbacks handled if issues arise?
  • How are releases coordinated across teams?

Evaluating IT infrastructure

  • What core systems are used (issue tracking, source control, CI/CD, etc)?
  • What is the technology stack (languages, frameworks, databases, etc)?
  • How scalable is the infrastructure? Can it support growth?
  • What physical and cloud resources are leveraged?
  • How are systems monitored, managed, and secured?

Evacuation strategy evaluation

  • Do you run and test backups on a regular basis?
  • Does it have an established procedure for dealing with disasters?
  • How many back-ups are there for mission-critical systems?
  • What is the time required to restore systems in the case of an outage?
  • Concerning data breaches and cybersecurity, how are these issues addressed?
  • To lessen technological risk and make sure there are no big holes that could affect the deal’s performance, it’s important to evaluate technology operations thoroughly. You can see the big picture by looking at procedures, infrastructure, and plans.

Reviewing Vendor and Supplier Agreements

During technical due diligence, it is crucial to properly evaluate a company’s relationships with its suppliers and technology providers. The initial phase involves documenting all suppliers and vendors that the firm depends on, followed by a thorough analysis of all service agreements and contracts. Lastly, an assessment of the risks associated with vendor dependencies is conducted.

Conclusion

Technical due diligence is a crucial process for assessing technology assets, operations, and risks in potential investments or acquisitions. It involves extensive analysis of areas like intellectual property, vendor agreements, technology costs, and team capabilities. Thorough due diligence provides insights that inform decisions, guide integration planning, and accelerate growth and innovation. Despite its time and expertise, it returns investment through successful outcomes.

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