From The Due Diligence Show (Episode 3), as the pressure of the deal clock ticks, it’s easy for tech acquirers to get caught up in revenue projections, legal and HR, when they need to stay core to the actual target’s function, the product they sell.

We chat about how the value of technology due diligence is often a misunderstood area of the M&A process.

Many acquirers consider technology as a “tick box” item that is simply covered contractually, the problem is that if the core tech asset that drives a company’s revenue can look great at face value, but can often be poorly executed and unfit for the buyers “deal thesis”.

Beyond inspecting the source code asset, there are many complementary activities that the Thought Source team discuss which will bring material information to the other diligence work streams such as customer sentiment, future fit and scale, potential misuse of open source, key contributor retainment, future team investment and more

Adam Jaques: Well welcome back to our next episode. We’re here in the deal room talking about due diligence during technology acquisition. A lot of folks think that you know, technology is really a tick in the box. We’ve checked some licensing and we’ve done a few other bits and pieces but we’ll focus a lot of the time on finance, legal HR, or those other work streams. But technology due diligence is not only about the source code and looking at that, but it rolls into a lot of those other work streams.

Luke Silcock: What’s going to come through as we explore this Adam, is that the tech dd work stream crosses over with many others. We find out about the people. We find out about the culture. We find out about what basically what makes the place tick. We validate customer success is out there. The claimed evidence around customer success gets proven out. We look at the assets. We explore the source code and the architecture, the product possibilities, and really evidence behind the claims. As we do this we reveal a lot about management culture. Are they open, can they share and can they work cooperatively? Can they move out of startup mode? Or if they’re a standalone company, can they adopt some of the practices or work hand in hand with another management team? We’ve seen reverse takeover. Sometimes the talent being acquired is going to lead an entire division or line of business. We help reveal this information, share it with the leaders of the other workstreams. This helps make sure that you know that technology is not just a tick in the box. Technology gets amplified, and where it needs to work can be a profound, potentially showstopper item if not appropriate.

Andrew Borzycki: In many ways, the technology to diligence is very much about the core of what the company is actually doing. Technology runs all of our world and the legal and financial streams are vitally important because they’re focusing on making sure the company is legitimate, compliant and all those sorts of things. But that’s typically not why you buy a company. You don’t buy it because its accounts are compliant. You buy it because it does something and it will do something for your organization. And that’s why you go down this path. Make sure you understand why. Start with why.  Why do you want to buy this company? Have clarity about why you are going down this path? Do you want it for people? Do you want it for market share? Do you want it as a business as a going concern? And that’s why understanding that is so important.  Because it determines will something that’s could be considered bad and a showstopper with one sort of rationale, but becomes a minor issue in another and vice versa.

Luke Silcock: Andrew, let me let me interrupt you for a second. What if a company is concerned about revenue only or primarily driven by revenue? They go and acquire and look to acquire a technology that’s selling really well. You know, huge customer base, very popular. Why bother going down the path of technical due diligence if that’s the main focus?

Andrew Borzycki: On the surface all may be well. The company may be out there obviously got this revenue, they’re able to serve their customers. But does that actually match entirely what you want? And are they able to do that in the future? We may find as we dig deeper that this company are unable to evolve or update or maintain what they’ve got, so they can’t respond to market needs. It may be incredibly difficult to actually do anything. And the team, the people behind it all may be caretakers who are able to keep things going but they can’t actually evolve it. So that means you are unable to adapt to the market as it changes.

Luke Silcock: If on top of that revenue, you’re paying at a high multiple, that implies a growth curve. When we talk about exploring, the deal thesis may be a 10x growth path x being the number of customers being served today. And some of our clients are looking at achieving that or sometimes 100 times type of assessment. We’re looking for scalability. Will it keep performing? Can they onboard these new customers? Maybe they’ve got where they are by basically taking the core R&D teams and using those folks and they’re busy bringing on board these customers and maybe that hockey stick does look fantastic. But the diligence we’ll do is reveal what’s inside the machine. What’s happening. Is that a clean well managed operation that it’s ready to scale? It’s not a rubber stamp or a ticking the box but a proper an appreciation, proper understanding of what is happening.

Andrew Borzycki: The tech industry in is so hype focused. Getting a clarity of what’s truly actually going on where they are where they’re going to be is difficult. I mean, we all remember Theranos, which was in the in the biotech space, which was valued at $10 billion. It turns out to have been that nothing there. Literally it was just something that did not exist. So you need to go beyond the PowerPoint to actually work out what’s real. And this is important because if you’re going to spend all this money on buying a company, make sure that you’re able to actually get the return on the investment that you seek.

Luke Silcock: Let me go back to the two initial workstreams you talked about legal and finance. Now normally we’ll provide information to those folks. They’ll base some of their conclusions and evidence on say, IP ownership based on findings around contributor histories. Also, any forward valuations in terms of finance are going to be based off an expectation or knowledge that the customers are real, they’re actually there. If they have deployed solutions and if it’s an as a service, we’ll be looking at the monitoring dashboards that show the workload on the service. If it’s been deployed in the field, we’re looking at the tickets that have come in that demonstrate that the customers are finding some issues but getting those solved. And all of those things are great proof points for those other work streams as well. That will then balance their advice and recommendations to the acquirer in mind with the reality of what they’re dealing with.

Andrew Borzycki: When we’re talking about tech due diligence, we’re really covering the end to end gamut of everything. We’ve got the source code asset, the licensing the architecture, the way it’s tested, the way it’s supported, the way it’s sold, the way it’s packaged, the IT systems within the organization, sometimes the back office line of business applications as well. Cyber security is another important area. It’s that whole range of technology that’s baked into the company, whether it’s from the product all the way through to the way the business actually operates.

Luke Silcock: You don’t have much time to do it. You need to have a process. You need to have a project team that is able to get it done in a short amount of time. You’ve signed up an LOI, letter of intent and you’ve got this limited amount of time to get this stuff done. So that’s another key fact that you can’t just keep working on it until you’re done. You’re given a time box, come back with material findings. What’s material for one deal might not be material for another one. So that’s where you have to balance it out.

Andrew Borzycki: That time boxing you mentioned, that’s the key element because I know after I’ve done some of these projects, we’ve had conversations with people wondering “Well, what about this? What about that?” We’ve got to use the judgment to actually make sure that we can reach those material findings in a very short period of time. Which is the art of actually knowing where to dig and what to sort of save for later.

Adam Jaques: Okay, well, I think we’ve done that topic. Well guys. Next episode, let’s talk about pre deal activities. What we can do before an LOI is signed, what you can do even before you decide which company you’re going to buy. There’s a lot of information we find out for our clients and a lot of really powerful things that can be brought to a buyer to really help them shape, what type of company, what type of technology they’d like to acquire. So, we’ll speak to you all soon.




The Thought Source team have produced a video series covering the "behind the scenes" of performing technical due diligence for M&A projects.

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