Technical Due Diligence: Friend or Foe for Acquisitions?

When it comes to mergers and acquisitions (M&A), technical due diligence often plays a critical, albeit sometimes misunderstood, role. For those navigating the complexity of acquiring a company, particularly in today’s tech-driven landscape, technical due diligence can be seen as both a crucial ally and, at times, an unexpected adversary. But which is it—a friend or foe?

What is Technical Due Diligence?

Technical due diligence is the process of evaluating a target company’s technology infrastructure, product development capabilities, software architecture, IT security, and the skills and structure of its technical team. This in-depth assessment seeks to uncover potential risks, opportunities, and areas for improvement in the company’s technology stack.

From understanding the scalability of a tech platform to uncovering hidden technical debt, this process has become increasingly important for both tech-centric businesses and traditional companies integrating more digital operations.

Why Some Consider Technical Due Diligence a “Foe”

For some, the introduction of technical due diligence can feel like a hurdle—an obstacle standing in the way of closing a deal. Here’s why it may sometimes be viewed as a foe:

1. Uncovering Unpleasant Surprises: Investors are often optimistic when approaching a deal, but technical due diligence can bring to light unanticipated issues such as legacy systems, outdated codebases, security vulnerabilities, or massive technical debt. These discoveries may delay the deal or even lead to a re-evaluation of the entire investment strategy.
2. Deal Delays: Conducting thorough technical due diligence requires time. It can slow down the momentum of an acquisition, especially when investors are eager to close quickly. If not well-planned or efficiently executed, this process can lead to deal fatigue, where parties become frustrated by delays.
3. Added Costs: Technical due diligence can require the involvement of external experts, who come with additional costs. For smaller acquisitions, where budgets are tighter, the expense of a deep technical evaluation may feel excessive, further straining the relationship between buyers and sellers.
4. Scope Creep: Without a clear framework, technical due diligence can expand beyond its intended scope, adding layers of complexity to the acquisition process. If not well-managed, it can lead to over-analysis, which may derail decision-making.

Why Technical Due Diligence is a “Friend”

Despite these perceived challenges, technical due diligence is overwhelmingly a friend to both investors and companies, delivering crucial insights that can define the success of an acquisition. Here’s why:

1. Risk Mitigation: One of the core functions of technical due diligence is to reveal hidden risks. Identifying issues such as unscalable technology, weak cybersecurity practices, or significant technical debt early on allows investors to better negotiate terms, plan necessary post-acquisition investments, or avoid costly mistakes altogether. The short-term discomfort of discovering problems is outweighed by the long-term value of knowing what you’re really acquiring.
2. Informed Decision-Making: Technical due diligence provides private equity investors with a deep understanding of the target company’s technological capabilities. This insight is key to making informed decisions about whether the company is a good fit, whether it requires substantial investment, or whether it has the potential for integration with other portfolio companies.
3. Value Creation: Technical due diligence doesn’t just identify risks—it can also uncover opportunities. By understanding the target company’s technology landscape, investors can spot areas where operational efficiencies can be gained, products can be improved, or new market opportunities can be exploited. When paired with a solid value creation plan, technical due diligence is instrumental in building a roadmap for post-acquisition success.
4. The First 100 Days: The early stages of a post-acquisition period are critical for setting the tone of integration and growth. Technical due diligence ensures that any necessary improvements or changes are planned and can be executed quickly, minimising disruption. It enables the investor to allocate resources effectively, addressing urgent needs while laying the groundwork for future expansion.
5. Negotiation Power: By highlighting potential technical challenges, investors are often able to negotiate better terms. For instance, if significant investment will be needed to upgrade infrastructure or address cybersecurity concerns, this can serve as leverage to reduce the purchase price or secure other favourable terms.

Friend or Foe? It Depends on Your Perspective

Whether technical due diligence feels like a friend or a foe depends largely on your approach to it. From an investor’s perspective, it’s an invaluable tool for minimising risk and maximising value. However, for those focused solely on closing deals quickly or hoping to bypass potential issues, it may seem like an obstacle.

Here are a few factors that can influence whether technical due diligence is seen as a friend or foe:

• Expectations Management: If you go into the process expecting a quick, clean deal without any technical issues, you may be frustrated by the findings. However, if you recognize the process as essential to uncovering the full picture, you’ll be better prepared to handle any revelations.
• Timing and Resources: Properly planning for technical due diligence early in the acquisition process can prevent last-minute surprises and reduce the feeling of it being an afterthought that disrupts closing.
• Attitude Toward Risk: If you view technical risk as something to be understood and managed, technical due diligence will feel like a valuable friend. However, if your focus is on avoiding risk entirely, the process may highlight too many potential hurdles for comfort.

How to Turn Technical Due Diligence into a Clear Ally

To ensure that technical due diligence works in your favour, here are some best practices:

1. Define the Scope Early: Make sure there’s a clear understanding of what technical due diligence will cover. Whether it’s software architecture, product scalability, or cybersecurity, defining the scope prevents unnecessary delays and ensures the process remains focused.
2. Use Experts: Bring in experienced technical advisors or teams who understand your industry and the specific technical challenges you’re likely to face. A skilled team can identify potential red flags without creating unnecessary alarm.
3. Communicate Transparently: Keep open lines of communication with both your technical due diligence team and the target company. Transparency helps manage expectations and ensures that everyone is on the same page regarding timelines and potential issues.
4. Plan for Post-Acquisition: Use the findings of the technical due diligence process to shape your post-acquisition strategy. Whether it’s fixing technical debt or enhancing infrastructure, having a clear plan for the first 100 days ensures a smoother transition and maximises value.

Conclusion

While technical due diligence may initially seem like a potential obstacle to fast-tracking acquisitions, it’s ultimately a powerful ally in ensuring long-term success. It provides critical insights that protect investors from hidden risks, enhance decision-making, and uncover opportunities for growth. When approached correctly, technical due diligence is not just a friend—it’s an indispensable part of a successful acquisition strategy.

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