The criticality of technology due diligence in 2023: a guide for private equity firms amid rising interest rates and layoffs
Ensure technological viability and assess the situation BEFORE the transaction closes
The private equity landscape in 2023 is facing unique challenges with rising interest rates, a recent wave of layoffs and the growing importance of technology in determining the success of portfolio companies. In this environment, technology due diligence has become a crucial component of the investment process. Thoroughly evaluating the technological viability of potential investments is essential for private equity firms looking to make informed decisions, mitigate risks and ensure long-term value creation.
This article will cover the importance of technology due diligence in the current market, the key elements of a comprehensive technology assessment and practical tips for conducting a thorough evaluation.
The growing importance of technology due diligence in 2023
The increasing reliance on technology across all industries has intensified the need for private equity firms to conduct comprehensive technology due diligence. Amid rising interest rates and a climate of economic uncertainty, investors must ensure that their target companies have robust, scalable and secure technology infrastructure in place.
Assessing the technology stack, intellectual property and cybersecurity posture of potential investments is essential for understanding the opportunities and risks associated with each target company.
Not doing thorough tech due diligence can lead to catastrophic consequences including financial loss, security breaches and slow/non-existent growth due to “tech debt”.
Tech debt: you don’t want it, strongly consider rework costs if you discover tech debt
“Tech debt”, short for technical debt, is a concept in software development that refers to the accumulation of suboptimal decisions, shortcuts and compromises made during the development process that can lead to a less efficient and more difficult-to-maintain codebase in the long run. These decisions might be made for a variety of reasons, including tight deadlines, budget constraints or a lack of knowledge or experience.
Technical debt can manifest in various forms, such as:
Code debt: poorly written or structured code that is hard to understand, modify or debug.
Architectural debt: suboptimal system design that creates inefficiencies or limits the system's ability to scale.
Documentation debt: incomplete, outdated or unclear documentation that hinders the onboarding of new team members or the understanding of the system's functionality.
Testing debt: insufficient or inadequate testing procedures that fail to identify bugs or issues before the software is deployed.
Tooling debt: relying on outdated or inappropriate tools or technologies that slow down development or limit the project's potential. For example, the use of outdated tools like Microsoft Access for production-level applications can significantly limit a project's potential.
Overly complicated systems: such as setting up an AWS instance across multiple regions for an app with less than 1,000 active users, which can lead to unnecessary complexity and increased costs.
Technical debt can have significant consequences for a software project, including:
Increased maintenance costs: as the complexity of the codebase grows, it becomes more difficult and time-consuming to address issues or implement new features.
Lower productivity: developers may spend more time trying to understand and navigate the tangled codebase than actually writing new code.
Reduced flexibility: a system with a high level of technical debt may be harder to adapt to new requirements or technologies.
Poor performance: suboptimal design choices or coding practices can lead to a less efficient and less performant end product.
Higher risk: the likelihood of introducing new bugs or issues increases as the codebase becomes more complex and harder to manage.
Managing technical debt is crucial for the long-term success of a technology-related investment. This can involve regularly reviewing and refactoring the code, investing in better tools and technologies, improving documentation and prioritizing testing and quality assurance processes. By addressing technical debt as early as possible, software development teams can maintain a healthy, efficient and scalable codebase that is easier to work with and adapt to changing requirements.
If the group pitching you does not have technical co-founders, consider NOT investing as a lack of understanding of technology from the portfolio company leadership team can lead to particularly difficult to address tech debt and unique challenges in communication. This can be mitigated by the future placement of a qualified CTO and internal team as a requirement of investment.
Bottom line: while tech debt is a relatively common situation, a lot of technology pitched by early-stage companies is tech debt and practically “worthless” due to needing to be overhauled or completely replaced. If a group pitching you cannot clearly show you how the system is built, technical documentation and a clear future development plan, consider setting milestone-based investment infusions to control for the high risk of companies with tech debt.
Key elements of technology due diligence
A comprehensive technology due diligence process should cover the following key areas:
Technology stack: evaluating the target company's technology stack involves understanding the current systems, platforms and tools in use. This assessment includes reviewing the software, hardware and network components to determine their compatibility, scalability and potential for future growth.
Cybersecurity: ensuring that the target company has a robust cybersecurity posture is vital to mitigate the risks of data breaches and other cyber threats. This evaluation should cover the company's security policies, practices and technology infrastructure.
Existing technology team: assessing the skills, experience and capabilities of the target company's technology team is essential to determine if they can support the organization's growth and innovation objectives.
Technology roadmap: reviewing the target company's technology strategy and roadmap can help private equity firms understand the organization's vision for the future and how technology will support its growth objectives.
Intellectual property: assessing the target company's intellectual property (IP) portfolio is critical for understanding its competitive advantage and the potential for IP-related risks. This analysis involves reviewing proprietary systems, expertise, patents, copyrights, trademarks and trade secrets to gauge the strength of the company's IP position.
Conducting thorough technology due diligence
Private equity firms should keep the following best practices in mind when conducting technology due diligence:
Engage a multidisciplinary team like Easie: technology due diligence is a complex process that requires expertise in various domains, such as software development, data management and cybersecurity. Engaging a multidisciplinary team of experts can ensure a thorough evaluation of the target company's technology.
Perform a gap analysis: comparing the target company's technology capabilities with industry best practices and benchmarks can help identify potential gaps and areas for improvement. This analysis can provide valuable insights for crafting a post-acquisition technology strategy.
Evaluate technology-related risks: a comprehensive risk assessment should consider both the potential risks associated with the target company's technology and the risks that may arise due to the acquisition. Identifying these risks upfront can help private equity firms plan for risk mitigation and management strategies.
Consider the integration challenges: private equity firms should assess the potential integration challenges associated with the target company's technology. Understanding these challenges and planning for them can help streamline the post-acquisition integration process.
Conclusion
In 2023, private equity firms must navigate a complex landscape marked by rising interest rates, economic uncertainty and an increasing reliance on technology across industries. Conducting thorough technology due diligence is essential to mitigate risks, make informed investment decisions and ensure long-term value creation. By focusing on key elements such as the technology stack, intellectual property, cybersecurity, technology team and technology roadmap, private equity firms can gain a comprehensive understanding of the opportunities and challenges associated with potential investments.
At Easie, we specialize in conducting technology due diligence that helps private equity firms navigate this complex landscape with confidence. Our multidisciplinary team of experts is equipped to assess the technological viability of potential investments, uncover hidden risks and provide actionable insights to support your investment decisions.
By partnering with Easie, you can ensure that your portfolio companies have the robust, scalable and secure technology infrastructure needed for long-term success.
Don't let technical debt or other technology-related risks undermine your investments. Book a consultation with Easie today and discover how our technology due diligence services can help you make informed decisions, minimize risks and maximize the value of your portfolio.