Preparing for Tech Diligence/Exit
Why is preparing for tech diligence important? What are the consequences of poor planning?
Tech diligence can derail the transaction – an investment group or another company is spending a lot of money to buy a portion (or all) of your company. Big money is at stake and doing poorly in tech diligence could affect your company’s valuation or, worst case, kill the transaction.
What is tech diligence? How is it different if your company is being acquired by a strategic vs. a PE firm?
Technical due diligence is the process investors use to understand the technology team and technology product they’re buying – it is one of many diligence streams that they will conduct. Remember, at the point in time where they agree to the terms for the deal, the investors have little information about the business and technology. The diligence process is their chance to get a deeper understanding of the company and make sure the terms of the deal make financial sense for them. Tech diligence is the diligence stream which informs the investors about the product technology team, the processes used to build the product, and the product itself (from a tech perspective).
Growth-stage private equity investors are most interested in your team – growth-stage investors recognize that you’ve built a successful business and they are hopeful that you know how to continue to scale your team, your processes, and the technology.
Technical diligence done by a strategic acquirer may vary depending on their objectives for the acquisition – they are buying your company for your team, your customers, or your product; or some combination of those three. It will help you prepare for diligence if you can find out their objectives.
Who usually conducts tech diligence?
Third-party former operators – Some investors will hire a firm (such as Clover Group) who specializes in tech diligence. The auditors are typically prior operators (e.g., former CTOs and VPEs) who have made diligence their full-time job. They have an entire career’s worth of hands-on experience doing the job you now do. They have a depth and breadth of knowledge and will be able to talk with you and your team down to a great level of detail. They will likely impart advice throughout the process, based on their own knowledge and experience and what they’ve seen at other companies. They can also give you some perspective about how your practices compare to other similar size and stage companies.
Existing portfolio company CTOs – Some investors (particularly for earlier Series A or B rounds) may simply ask a CTO at one of their portfolio companies to spend a couple hours on the phone with you. These folks have deep hands-on knowledge and be able to talk shop, but their diligence process will be less rigorous and comprehensive as it’s not something they are focused on developing.
Large consulting firms – these firms, like Anderson, are typically used for large later round (e.g., Series D and later) investments. The auditors tend to be business consultants without prior operator experience.
Oftentimes, nobody – many investments occur without any technical diligence, but increasingly earlier stage investors are recognizing the value in derisking their investments and seeing the ability for tech diligence to create greater long-term value in their investments.
When in the acquisition process does diligence occur and how much notice will you have?
Diligence kicks off as soon as the term sheet is signed – most often, few employees aside from the CEO and co-founders know the transaction has been brewing. Once the term sheet is signed, tech diligence will start and you will suddenly find yourself in a kickoff meeting with the auditors, usually within 24 hours.
What should you expect to happen during the tech diligence process? What should you do at each stage? What shouldn’t you do?
| Kickoff Meeting | ||
| What it is | An introductory call to explain who the auditor is, what the process looks like, and review the timeline | |
| What to do | – Listen – Be on time – If it is a video conference, turn on your video | |
| Things to avoid | – Do not be combative – Do not ask to extend the proposed tech diligence timeline (unless you absolutely must) | |
| Tech Questionnaire | ||
| What it is | A questionnaire for you to fill out which gives the diligence vendor the basic information about your team, tech, and processes | |
| What to do | – Finish it on-time (or early for bonus points) — it shows you’re organized at managing your time – Be honest – Communicate clearly and succinctly – If you’ve had other people contribute to answering the questionnaire, review their answers — you don’t want to be surprised in the diligence conference by something negative or incorrect a colleague might have written | |
| Things to avoid | – Do not return it late – Do not continue working on the questionnaire after the due date – Do not leave answers blank – Do not volunteer more information than you’re asked for | |
| Product Demo | ||
| What it is | A live demonstration of the product. Oftentimes, the acquirer and the auditor(s) will join this call. | |
| What to do | – The person giving the demo should be fluent in the product, have a crisp understanding of how customers use the product, and give demos often. The Head of Product usually does this. – Have a script and walk through how most customers use your product. | |
| Things to avoid | – If the auditor asks for a demo, do not insist on sending a recorded demo. – Do not attempt to demo every product feature (unless the auditor asks for this) – Do not meander through the product showing seemingly random features. The demo should be firmly rooted in how users use the product. | |
| Diligence Conference | ||
| What it is | The engineering leader spends a day (or more) room with the auditor. You’ll discuss your team, processes, and product. Unless they tell you otherwise, the auditors will drive the agenda and bring questions. These are typically done in-person with the auditor traveling to your office. | |
| What to do | – In the days before the diligence conference, gather some of your team and rehearse talking through some of the things that you’re likely to be asked about — practice describing and whiteboarding your product architecture, explain why you’ve chosen the team structure that you have, describe your hiring plan for the next twelve months, show a few ops dashboards which you use to monitor production, etc. – Bring in subject matter experts selectively (e.g., architect, DevOps) – Ensure people invited are good communicators, not just good technologists – Follow the auditor’s lead, but you probably want to keep the room as small as possible. Only invite people who need to actively contribute. Excuse people when they are no longer necessary for the conversation. – Be concise and honest without oversharing – Unless the auditor says otherwise, order lunch and have it delivered to the meeting room | |
| Things to avoid | – Do not keep people lurking in the conference call/room if the conversation has moved on to a new topic which is outside their area of expertise. If the diligence conference is a video conference and someone is muted and has their video turned off, they probably don’t need to be in the meeting. – Do not offer more information than you are asked – Do not insist that the auditors provide you with a list of questions that will be asked | |
Who on your team should be involved in preparing for tech diligence?
Engineering leader (e.g., CTO, VPE, etc) – they are the primary person responsible for your company’s response to tech diligence. At a smaller company, they may be able to complete the tech questionnaire and documentation request entirely themselves.
Product leader (e.g., CPO, VP Product, etc.) – this will vary by auditor. Some vendors are solely tech whereas others will include assessing the Product team and product management practices.
Others can contribute to filling out the tech questionnaire and even participate in the diligence conference—but only if they offer a valuable perspective – the head of SRE or infrastructure, the head of DevOps, or even the CEO may contribute to the questionnaire and the diligence conference.
What topics will be covered during tech diligence?
Exact topics and depth will vary by auditor. Broadly, they will assess the product technology team, your processes, the product, and the hosting infrastructure.
Product, Engineering, and Design Team
- Leadership
- Team structure and composition
- Management practices
- Scalability
Process
- Product management
- Development process
- Quality process
- Release process
- Scalability
- Security Policies
- Compliance
Product
- Architecture
- Tech stack
- Open source compliance
- Integrations
- Security
- Scalability
Infrastructure
- Hosting & tenancy
- Security
- Scalability
- Availability
- Observability
- Disaster recovery
How do you make the best possible impression on the auditor?
Research your auditor – look at their career history on LinkedIn and the kind of companies they’ve worked for (e.g., mainly B2C or B2B? Startups? Large companies?). Watch/read any podcasts, conference talks, or Medium articles they’ve taken the time to publish. All of this material can tell you a lot about the person you’re about to spend a day locked in a conference room with and what topics they might dig into.
Diligence is a game of impression management – everyone knows that first impressions are important. In diligence, your first impression will probably be the only impression you get to make. Be the most professional and punctual version of yourself.
Ask questions – tech diligence is the most fun and productive for both parties when it’s a conversation. Asking questions can show that you’re open-minded and welcoming of other ideas.
What should you do if you think your organization or product has a weak spot? How can you make your flaws palatable to auditors and acquirers?
Have a plan – if the conversation turns to something you’re less proud of, that’s ok. Be honest about the current state, acknowledge that you’re aware it needs work, and present how you plan to improve it.
Ask questions – ask the auditor what they would do or what they’ve seen at other companies. This sneaky trip appeals to the auditor’s vanity.
What are the most important things to get right?
Research your auditor ahead of time – this is crucial to give you an informed perspective on how to prepare and what you can expect.
Be professional and punctual – you’re only going to get to make one first impression; make it a good one.
What are common mistakes?
Be professional – it’s low-hanging fruit, but don’t be late to meetings, don’t be late completing the questionnaire, and don’t say bad things about your coworkers. Most people are professional and on time, so you don’t want to be the one out of ten that presents poorly. Failing to be professional is an immediate red flag to investors.
Know how to receive feedback – don’t argue with feedback — diligence isn’t the time for that conversation. Say “thank you” and move on.
Are there any books I can read that will help me prepare for tech diligence?
Read Accelerate and Inspired – these books will not only help you prepare for diligence, plainly put, they will help you be the best software professional you can be. These two books represent a veritable Product Management 101 and Product Delivery 101. If you read these and find yourself nodding your head through all the practices they describe, then you are doing a fantastic job and you’ll do fine in tech diligence.
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