Technical Due Diligence

Before companies can complete a successful merger or acquisition, they need to know what they can expect from the other party. This involves a detailed process of due diligence, or an examination of an organization’s operations, financial information and technology. For technology-driven targets, technical due diligence is one of the key steps in determining the value of the deal, as well as potential pitfalls or liabilities involved in the integration.

Understanding the details of the organization’s tech stack, intellectual property and data security can help companies to assess the risks and assets inherent in the deal. This evaluation requires technical expertise to verify code, IP, security and other aspects of the technology. Since a thorough analysis involves a significant review of massive quantities of information, robust data rooms can simplify the work of gathering, processing, hosting and protecting sensitive information. With this guide, companies will understand the fundamental components of tech due diligence, as well as how they can implement it successfully.

Defining Technical Due Diligence

Technology due diligence is a comprehensive inspection of the organization’s software and systems, looking for weaknesses and liabilities that may hinder a successful merger or acquisition. Common aspects include:

• Code Review: Inspecting code for usability and maintenance of technology assets, while highlighting vulnerabilities
• Product Architecture: Assessing the product architecture for maturity and scalability
• IP Ownership: Confirming ownership over key IP for the property, while identifying liabilities like potential licensing disputes
• Security Audits: Evaluating the security of various company systems, to minimize risks of system failure or unauthorized access

Although technical due diligence might be completed at the same time as other aspects of due diligence, they often require different processes and teams to complete the work. Financial due diligence relies on financial experts who specialize in operations, accounting, reporting, compliance and more. Similarly, tech due diligence requires engineers, IT security specialists and other subject-matter experts to process and appraise information.

Key Areas of Focus in Technical Due Diligence

As part of an M&A due diligence checklist, companies and investors should evaluate the organization’s technology. Technology, ranging from the software that businesses use to the way that they handle security and management, provides key details about potential assets or conflicts during a merger or acquisition. Gaining this information can help companies determine if the technology is suitable for integration or if the M&A is a wise choice at all.

Software/product architecture

The architecture of the software requires extensive analysis for quality, maintainability, scalability and the ability to integrate with the acquiring company’s existing system. Code reviews reveal maintenance and updates, as well as development history, to identify whether the code needs a significant overhaul to scale for continued growth.

Cybersecurity and data protection

Evaluating the system’s cybersecurity and data protection is a key component of regulatory compliance, to ensure that the software is unlikely to break down or release sensitive information during a breach. A thorough examination can show if the system is able to handle common attacks to security, with an identification of weaknesses or patch backlogs that create vulnerabilities.

Intellectual property validity

Control over intellectual property gives companies the comfort of knowing that they can expand, adapt or make changes to the existing technology, without worrying about breaking existing licenses or contracts. An inspection of the organization’s IP shows whether companies need to investigate open-source licensing requirements or possible infringement claims.

Team and processes

More than just the software and technology in use, thorough technical due diligence involves an evaluation of the systems and processes used by the development and technical teams. This assessment should include discussion with technical experts in the company, to consider development practices, quality assurance and other processes.

Role of a Virtual Data Room (VDR) in Technical Due Diligence

With a number of potential parties completing aspects of the checklist and reviewing collected information, a due diligence data room can be a practical tool as part of the process. Virtual data rooms streamline the collection of technical documents, by allowing a single repository that is accessible remotely by the diligence team and key stakeholders. Advantages of this technology include:

• Document Structuring and Permissions: Complicated document trees become easy to categorize and determine access.
• Q&A/Collaboration: Software allows teams to ask for clarification, track the status of open items, or collaborate to complete tasks efficiently.
• Security and Compliance: The use of encryption, watermarks, user monitoring and other features can help to prevent unauthorized viewing or copying of sensitive IP.

As a virtual data room provider, DFIN helps to manage complex workflows, ensuring a high level of accuracy and compliance.

Best Practices & Pitfalls for Technical Due Diligence

The M&A Community reports that the average merger or acquisition takes five to six months, which does not leave a lot of time for the tech due diligence process. Companies who plan to complete a successful deal should use these practices to ensure they get the information they need to make informed decisions.

Plan early

The technical due diligence process may only last several weeks, which calls for early planning. Well in advance of digging into code review and other aspects of the checklist, the diligence team should communicate with tech experts and request comprehensive documentation. Executing a detailed plan can help to ensure that the evaluation stays on the rails.

Use consistent frameworks

A tight M&A timeline requires a consistent framework for evaluation and testing. Companies should rely on standardized checklists to assess the architecture, code quality and security. A standard process for evaluation helps organizations to avoid missing key items, while making existing problems easier to find and replicate.

Identify document gaps

Technology due diligence often reveals inconsistent or insufficient internal documentation, which can stall the review process. As a response, companies should leave enough time to perform additional code reviews or request supplemental documentation.

Repeat review

At times, the early review process will highlight several potential red flags, such as a suboptimal code base or obvious difficulties with scalability. The plan should leave space in the schedule to complete additional assessments to determine if the problems have been addressed.

Common pitfalls

During the technical due diligence process, companies may face a number of pitfalls due to a lack of planning or sufficient timeline for the review. These pitfalls include:

• Failing to sufficiently review the code, leaving errors and vulnerabilities to show up over time
• Assembling incomplete documentation, which may lead to faulty decision-making
• Ignoring open-source licensing constraints, which can limit development and scalability

Making a commitment to thorough tech due diligence can help companies confirm that the merger or acquisition makes sense, as well as avoiding technical risks with integration.

Post-Due Diligence Action & Integration

A thorough technology due diligence process can reveal necessary actions that companies can or should take regarding the merger or acquisition. Significant issues, such as a need to change platforms or overhaul security, may call for a renegotiation of the valuation or indemnities. In the absence of significant problems, complete due diligence helps to create a post-merger integration roadmap, highlighting strengths and potential weaknesses. This level of detail can assist with immediate plans to merge IT systems, code repositories and development teams.

Although due diligence is designed to identify the function of a company or product in advance of a merger or acquisition, it continues to be a viable tool for information and planning in the future. Companies can use the collected data to generate insights about upgrades, integrations and future growth. Continuous use of a secure platform like DFIN can help to ensure that the post-merger organization meets compliance requirements and integration goals.

DFIN Streamlines the Technical Due Diligence Process

No one wants to go through the effort of a merger or acquisition only to have the situation create a disaster during integration. The risks inherent to M&As highlight the importance of technology due diligence, especially for those with digital components and technical intellectual property. A careful evaluation of a company’s software and product architecture can identify potential issues that can be easily resolved or require renegotiation of the deal.

DFIN’s M&A software facilitates an effective exchange of information, while protecting data security and ensuring appropriate access. Teams can upload documents, review information and create valuable insight that can lead to data-driven decisions and successful deals. For more information about performing due diligence for your next M&A, explore DFIN’s virtual data room solutions or contact our team.