What to expect from Technical Due Diligence

All tech ventures raising capital or looking to exit their business must undergo technical due diligence (Tech DD). As with commercial due diligence, this will be towards the end of an extended funding or M&A process, and it might seem like a formality just before signing the dotted lines. However, there is excellent reasoning why VCs require a tech DD. This is the first time they will open the hood to your engine room, and there is a real risk of issues appearing that could lead to renegotiations about the agreed valuation. In the worst cases, we could be looking at dealbreakers.

At Lab08, we have both been the subject of tech DDs, while we have been performing tech DDs on behalf of VCs looking to invest in tech-based scale-ups. In this article, we will share our framework for conducting a tech DD and what you should be aware of if you engage in one at any point.

What is technical due diligence?

Tech DD includes an evaluation of the technical strategy, the team, the development process, product and code quality, and the system architecture and security.

Why do VCs want this?

For any tech venture, the actual technology must align with the demand for commercial performance and growth targets. A legacy (old) platform or product requires significant investment in competencies and time to modernize, which might not be accounted for in the presented investment plan. VCs are aware that legacy platforms come with slower development and higher turnover in the product team. Also, significant security issues might lead to a data breach or similar risks that VCs are unwilling to take. 

How to do technical due diligence?

Technical due diligence requires access to the company’s data and technical setup and management, including the CPO and the CTO. It will be performed by people with expertise in all areas relevant to the tech DD mentioned above. Typically, tech DD takes 2 to 4 weeks and will result in a rapport indicating potential risks in the above-mentioned areas. 

Lab08’s framework for technical due diligence

There are multiple ways to go about a tech DD, but any process will cover roughly the same topics. The big difference is how deep you go in each area. A “light” tech DD could be based on a few interviews with the CTO and a high-level architecture review. A proper tech DD will thoroughly examine the team, processes, code, and security to uncover potential hidden red flags in the software and infrastructure.

In Lab08, we are doing proper tech DDs, and we have developed a framework to cover and rate all the relevant topics in a way that is useful for investors and the subject of the tech DD. 

Product and tech strategy

Leadership and team

• Are the current tech and product leadership in place to execute the strategy?
• Does the hiring road map reflect the current plans to scale the business?
• Is the hiring plan based on realistic timing and cost assumptions?

Product Quality

• Is the code written in a well-structured and documented way?
• Is legacy code at the expected level compared to the age of the product?
• The level of automation, code coverage, and ability to catch bugs upstream?

Ways of working

• Ability to deliver quality on time to meet the roadmap and strategic goals?
• Are well-established processes for release and sprint planning in place?
• Effective setup for handling bug backlog and feedback on the product?

Infrastructure and security

• How are deployment processes compared to the current state of the business?
• Scalable infrastructure to accommodate the business and product strategy?
• Any major security breaches that need to be addressed?

Evaluating a tech due diligence

All tech companies have issues to deal with, and this should be no surprise to investors! The most critical output is to understand if there are unknown red flags and if the right plans are in place to address the issues. 

The best case is if the issues that have been shared during the investment process are already known. However, suppose the critical problems are new to both the subject of the investment and the investor. In that case, it could lead to a discussion about a need to increase investment in R&D to solve the issues or potentially a discount in valuation if the problems are severe enough.

How we evaluate a company

There is not only one way of presenting the conclusions of tech DD; this is just as much an exercise of making the findings easily accessible and understandable for the target audience. In Lab08, we are doing tech DDs for VCs and investors, and we have created a dashboard to quickly understand the conclusions for a non-technical target audience.

Each area in the due diligence is scored on a scale from 1 to 5 based on multiple interview sessions with the CTO, interviews with all team members in product and tech, code review and desk analysis of the shared information and a Penetration Test. 

The Baseline score is created by evaluating the current situation compared to the realistic expectations for the product and tech operation in the given growth scenario. By comparing the actual situation with the baseline, we can recommend which areas are in the most urgent need of attention to support the plans for scaling the business.

In an actual due diligence report, each of the five areas will be analyzed and described individually for the investor to have as many details as desired. Also, for the subject of the tech DD to have an actionable plan to work on post-investment.

In our experience, this executive summary combined with the more detailed report is what investors need to have the necessary information and confidence when investing in a tech start. This is how to avoid surprises after investing, which is in no one’s interest.

Get in touch to learn more

We hope that this has helped you to get a fundamental understanding of tech due diligence. What it is, and why it is needed. You are always welcome to reach out to us if you are an investor needing a partner doing tech DDs on your behalf or if you are a tech company preparing for future due diligence.

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