Technology Due Diligence Matters
When Paul and I started Sabio four years ago, we had a firm belief that technology due diligence is a critical component to the investment diligence process that private equity (PE) firms undertake during overall diligence, referring to it as the “third pillar” in the diligence foundation alongside financial diligence and legal diligence. This was the core premise on which we built the company, to focus on the market where we felt it would have the most impact – the middle market and lower middle market, or in our definition, companies with less than 250mm in gross revenues. At that time, we often found ourselves having to persuade PE firms that remained somewhat dubious of the need; however, as we flash forward to the present day, our belief has been proven out many times over.
Why is this the case? All companies today use technology to operate their business and, if a PE firm is considering a substantial investment in any target company, they need to know what is “under the hood” and what they are buying from a technology perspective.
In short, the technology a company uses to operate the business matters.
Technology matters from many standpoints – operational efficiency and effectiveness, ability to scale, ability to integrate future bolt-on acquisitions, and risk reduction to name a few – but ultimately, it matters to the bottom line and to investment returns. In rare circumstances, it may even kill a deal. This is especially true in smaller companies and doubly true for companies where technology is the primary commercial product (since technology is used to create a commercial product and to run their business).
In all cases, what matters much less is what we call technology “shoulds”, or, said another way, technology for technology’s sake. Because technology changes so rapidly, there is simply no way a smaller company can optimize every single component of the technology stack – it doesn’t help a PE firm to hear that the entire tech stack needs to be replaced and modernized, because that will almost never happen. The PE firm needs to know which technology components of the target company present the most significant risk to achieving their investment objectives.
As part of technology diligence, there is only one way to do this – the strategic business objectives and the underlying business operation of the target company must be fully understood in order to assess how the underlying technology supports and enables the PE firm’s value creation agenda (VCA). Some components will support the VCA, some will not and some are simply not important, all of which underscores the essence of technology diligence – the fundamental alignment between the current underlying technology and the future business strategy. Technology diligence must uncover the gaps, misalignment and risks to achieving business goals, then identify where additional investment may be required to enable the PE firm to make informed pre-close decisions regarding deal terms and/or the deal itself. Technology diligence must first focus on the business and second on the technology that enables the business.
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