May 12, 2020 Dushan Bilbija

New Diligence For A New World

As everyone is working their way through the “new normal”, organizations are re-thinking their processes and their approach to managing and growing their business. This is a great opportunity to look at your M&A deal flow and technical due diligence practices.

Here are some suggestions for a new approach to diligence:

Start your technical diligence before you sign the LOI.

Your diligence starts the moment research starts. You’re collecting information about the target company in all its various forms; technology should be included right at the start (after all, you’re not waiting to start financial or market diligence). Get your technical diligence partner involved so they’re not starting cold when you sign the LOI. Best practice should be to have some dedicated time for technology during pre-LOI management meetings (or even a dedicated call with the CTO). Even a handful of carefully chosen high-level questions can provide valuable insight that can help you start building the risk profile earlier in the process, and inform other diligence streams’ scope and key questions.

Don’t rely on your diligence partner for basic technical fluency.

Related to the above, engaging in meaningful discussions about technology should be a familiar and comfortable place for your deal team. Hiring subject matter experts to work through various diligences is good practice, certainly; however, technology is beyond the grasp of no one. Executives can read P&L sheets, discuss customer segmentation, and work through customer support bug charts; there’s no reason they can’t also identify components in an architecture diagram or discuss the advantages and disadvantages of microservices. Ask your diligence partner to hold tech talks, educate and equip your team with fundamentals to understand and evaluate what they are presented.

Avoid cutting the scope of technical diligence.

There are times when a summary report or high-level red flag report will suffice; there are times when your focus is architecture (perhaps a technology-only play). But discovery (discussions and documentation) should cover all aspects of technology from ideas to code. Leaving out discussion topics effectively means reducing the likelihood of finding potential issues. It’s all related. How the Engineering teams approach QA is related to the company’s security strategy; how the platform scales is related to Customer Support, Disaster Recovery, and Product Roadmap. In a situation with significant constraints, always look to cut the scope of discussions last.

Have a playbook that is less like a cookbook.

Cookbooks are checklists that you work through; they are relatively constant. But a playbook can (and often does) change. In sports, playbooks change with each opponent; they take into consideration the opposing team’s personnel, strengths, and weaknesses in order to modify the approach to that game. A repeatable process is crucial to keeping the deal flow streamlined, for sure, but simply going through a checklist and presenting a templated answer is problematic, at best. Your diligence partner should understand your investment thesis and deal nuances and tailor the deliverable accordingly. A deal focused on market expansion or new product development will likely have different mandates than one focused on platform consolidation. Sometimes a longer code review is warranted, or perhaps a deeper analysis into infrastructure costs and projections is needed. Your firm might have a higher risk tolerance for older technology or tend to avoid underwriting large platform changes.  The report should respect and address your firm’s values and strategy, as well as the specifics of the deal.

Get the same team from your diligence partner on every deal.

Consistency helps the M&A process at every turn; diligence teams with high variance are a missed opportunity to have someone who knows your firm, your portfolio, and can speak to your firm’s investment strategies. Ask your technical diligence partner to have a consistent set of team members; this will ensure some institutional knowledge is built up deal-to-deal. This consistency of participation will also help with understanding where it can contribute to your portfolio and how it compares to your previous investments. There’s an opportunity to build trust and mutual understanding which should not be overlooked.

Avoid spending significant time building technology slides for your IC deck.

Reports should be consumable and relevant; you should be able to read them cover-to-cover and gain material insights into how technology impacts your investment thesis. Your firm’s values, risk tolerance, underwriting goals/objectives should be easily recognized in the report. If you’re googling every other term, or if you’re asking yourself why you’re reading through a checklist of things you don’t care about or have no impact, these are clear indicators of deficient reports that don’t know or respect their audience. Ideally, you and your technical diligence partner have agreed on a report format that includes materials you can copy straight into your IC deck. Diligence reports should be tailored to your needs and allow your deal team to easily see how the presented evaluations trace back to the fundamental desired outcomes for the deal.

Lean on your technical diligence partner to find good companies.

Your diligence partner is a technical expert. When you’re thinking about verticals, meeting with companies in a specific market, or working through these discussions, include your technology diligence partner and get their opinion. They won’t have something to say about every industry & niche, but they’ll have something to say about many of them; if they don’t know the answer, they should be able to get one from their network. Sourcing a good deal starts with finding the right market and the right company; lean on your technical diligence partner to provide you with insight.

Get a CTO.

This one deserves its own discussion… more to come.

The road ahead

Getting a clear view of technology is the responsibility of technical due diligence; it can only benefit from a revisit of some things that have come to have been accepted as the norm. There’s no doubt that the “new normal” will present some challenges. It’s important to know that some of those challenges will induce a new way of doing things that is better and moves us beyond the status quo.

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