Why Technical Due Diligence Is So Important for Startups?

Building a profitable business is a major challenge. Making such a business transparent and operable is even more difficult. That is why there are guidelines allowing companies to audit and check all their business operations to ensure adherence to existing laws and regulations. The same applies across the entire infrastructure. 

When narrowing due diligence down, one receives technical due diligence. It is one of the key instruments allowing investors to determine whether your business processes are transparent enough to be perceived as credible. Without further ado, we’ll explore the phenomenon of technical due diligence, investigate its key stages, and present a checklist of what startups need to do to stay competitive and attract investment. 

What is Technical Due Diligence?

Before speaking about technical due diligence further, it is crucial to establish a pre-text. What is due diligence? Essentially, it is a type of investigation, audit, or review to confirm a particular matter under consideration. What does due diligence mean? It means that some aspects of a company’s business operations are investigated to determine whether everything is transparent and adheres to existing rules and regulations.

A due diligence example is the following — there is a company that plans the acquisition of a smaller business. In such a case, due diligence will examine the firm one intends to but determine whether it is a sound investment in the first place. 

What is technical due diligence? Technical due diligence (TDD) is an in-depth examination of the company’s technical infrastructure and architecture. It often revolves around aspects like operations, IT staff, and processes. Usually, TDD is performed to determine whether the current infrastructure and architecture can handle scaling and growth. Additionally, TDD can be performed to evaluate internal operations and security.  

Going further, TDD is a comprehensive check of the product's technical condition. Aspects like code quality and risks can be presented as viable elements of the TDD. Essentially, the approach offers a development team valuable insights in uncovering the strengths and weaknesses of the product. Equipped with such information, investors can decide whether to further work with your product or not. 

Often, reasons for conducting a TDD can vary. Yet, it covers the range of elements one can check. From an understanding of the competence of a vendor planning to cooperate with to assessing the existing risks and testing the workload. All it comes to the following — types of due diligence depend on the needs of the party conducting it. 

The Importance of Technical Due Diligence

Companies undergo technical due diligence before M&A, fundraising, and venture capital financing. Investors use TDD to understand the risks and gains after exploring the technical state of your company and often make decisions concerning finalizing the deal based on the TDD’s outcomes. 

One should understand the key insight — even if you have a perfect Minimum Viable Product (MVP), it does not necessarily mean you receive funding and further investment. In such a case, due diligence documents are the best indication that you’ll receive the money you need to develop the product. However, to establish that your technical due diligence documents are good, prepare to see investors going through myriad interviews, tests, and documentation. They will focus on value, risks, tech infrastructure, and sustainability.

All the abovementioned things lead to what technical due diligence is good for. The following are the elements that will help prepare for TDD:

• Getting insights on strengths, weaknesses, and improvements. While knowing that TDD will occur, you can and should engage in self-audit measures. Essentially, you can determine your technical infrastructure's potential strengths and weaknesses. Doing this will expose the areas for improvement and help prevent particular issues that further TDD may uncover. Besides, doing self-audit even without technical due diligence is a great way to improve productivity and efficiency. A better grasp of the technical state of your company is a direct way toward success.
• Speeding up the process of M&A and avoiding legal issues. Pre-TDD evaluation can help find aspects of the business that can further do much dagame. For instance, you may find out that someone is using unlicensed software or there are potential infringements with intellectual property. Dealing with such issues beforehand will preserve nerves and finances. You will avoid potential litigation and ensure that your company appears before investors in its best shape. 
• Preparing staff for evaluation. A crucial part of TDD is about interviewing employees. You can prepare your staff for such interviews and ensure that people are ready to undergo them. The technical due diligence team will often ask about various technical processes, the logic behind particular decisions, and specific technical processes. Knowing that you can prepare people for what they are expected to undergo during TDD interviews. 

Knowing what technical due diligence is all about prepares you for various scenarios. Respectively, it is not worth underestimating the role of TDD. Namely, it determines whether your product receives further investment or your company undergoes a successful acquisition. Technical due diligence is important, and that’s why you should know how to prepare for it. Understanding the phenomenon’s stages will help with that. 

Technical Due Diligence Stages

Typically, technical due diligence does not last more than two or three weeks. Yet, if poor organization and management are at play, the process can stretch and become months. Keeping that in mind, TDD being conducted for too long can be a reason for breaking the deal. To ensure technical due diligence is on the right track and goes as planned, there are particular stages to adhere to:

1. Preparation. The technical due diligence process starts with all parties reaching the agreement through a letter of intent. Both investors and your company should sign it. The document is an important part of the preparation stage because it outlines how TDD will unravel and when one can say that the final agreement was reached. Besides, during the phase, both parties must sign a non-disclosure agreement (NDA). Confidence is important at all TDD stages. Moreover, if any other third party is involved in the technical due diligence process, they should also sign an NDA. 
2. Kick-off. The stage includes clearing out different due diligence processes like the timeline for every part, the scope of data used, the number of employee interviews, and how documentation will be exchanged. After determining the ins and outs of the processes as mentioned above your company needs to prepare all the required documentation for review. At this stage, make sure all the confidential documents are secured. It is best to keep them in some secure cloud repository. 
3. Research. This stage of technical due diligence involves a TDD team examining all the correlated documents. They will review the documentation on products, services, IP, internal operations, policies, software architecture, and IT assets. If that is not enough, they will likely look through security mechanisms, integrations, and third-party solutions. At this point, it is always best to anticipate the stage and explore the respective documentation in advance to be ready for the research part of TDD. 
4. Meeting. After the research and investigation phase is over, the investors will likely want to witness your company's technical side in action. Respectively, the stage is about testing the performance through on-premise and remote reviews. During the phase, investors will interview technical managers and some key human resource assets. 
5. Follow-up. The stage includes answering all the questions the technical due diligence team might have. Be aware that investors can ask various follow-up questions after the initial assessment and during every stage of the process. You can try to anticipate the potential questions and prepare for them in advance. 
6. Report. After all stages of TDD are complete, the technical due diligence team will offer a detailed report of the findings. It assesses all the value of your company and presents its technical condition in detail. Particular attention will be paid to potential risks and uncovered flaws. 

All the TDD stages mentioned above play an important role in the outcome of the process. While you cannot prepare for the report phase, the first five stages are the ones you can anticipate and envision. In addition, you can even say that the report phase will show how well you prepared for the TDD. To help you make the best of technical due diligence, the following are the key aspects to focus on. 

What to Consider Conducting Technical Due Diligence

While technical due diligence is a complex process consisting of many variables, there is still a particular manner of prioritization possible. These areas of consideration help make TDD as seamless as possible. The domains correlate to various aspects of TDD, including due diligence documents.

Products and services

In the technical due diligence investigation process, one should consider that the investors will necessarily examine your company’s services and software products. The process includes assessing technical specifications, surveys, studies, and on-site tests. What is more, be ready to illustrate market research and competitor analysis as a part of a technical due diligence investigation. 

With IT due diligence, it is vital to have a decent technology roadmap. In addition to the roadmap, it is also important to refine existing long-term business plans in advance. In simple terms, your products and services documents should be understandable enough for people reading them to easily get the scope, budget, and level of detail in the context of improvement and offerings.

Going further, this part of the analysis revolves around reviewing the company’s technological systems along with engineering practices. Consider that the examination will focus on aspects like programming languages, org structure, data centers, APIs, applications, and databases. These elements help anticipate potential security risks and show whether a company is ready for scalable growth. At this point, the products and services part of technological due diligence allows you to prepare for particular aspects of the given examination and show that your product or services is technically viable and can be used to scalable the company.

IT systems and architecture

Consider that the technical due diligence team will look at software and hardware after products and services. In such a case, the objective is to evaluate your IT assets regarding sustainability, effectiveness, and potential for integration with different services. To prepare for this type of due diligence, prepare employees to be able to justify the entire logic behind decision-making in the aspect of systems and architecture.

To illustrate, employees might prepare a report showing the statistics of using a serverless platform as the instrument for reducing operational costs along with maintenance in the long run. There are various ways of presenting and describing the primary technology adopted in your company and product. Do not forget to collect corresponding documentation, including architectural charts and performance indicators. What is more, to prepare for the TDD even more, you can have a comparison between your offering and the competitors’ offering.

Finally, ensure that you have enough documentation on IT systems and architecture. That is why it is crucial to archive documents. Elements like architectural descriptions, API documentation, and operational metrics provide a broader picture of your operations and system. It creates a great impression on the ability of your company to develop in time. 

Code and data quality

Checking code and data quality represent another important part of any technical due diligence analysis. When it comes to preparing for this aspect of the investigation, consider the following elements the investors might assess:

• Programming languages and open-source components
• Code coverage and its quality
• Agile practices
• Software development methodologies
• Server maintenance
• Server support
• Unit testing for data repositories

Such aspects also correlate to M&A due diligence checklist. Knowing what parts of your software and hardware the investors will look at grants an opportunity to prepare for all the unexpected scenarios and make sure you’ll show the investors what they want and would like to see. If all the aspects mentioned above are covered, you can be sure your code will be an easy read for other developers, perhaps those employed by the TDD investigation team. 

In turn, if your code is sloppy and your hardware does not have sufficient support and maintenance measures, it can impact the entire deal. Respectively, taking care of code and data quality gives your company a better edge within the scope of the whole deal. 

Intellectual property

Both tangible and intangible assets determine a company’s value. Be ready for investors to research your copyrights, patents, and trademarks. It is all done to ensure the product under investigation is well-protected. Dealing with intellectual property is extremely important because it provides there is no infringement on rights that can potentially cause any legal issues. 

It is worth noting that any organization or company, regardless of its size and value, can face massive challenges without proper intellectual property protection. To ensure your assets, patents, and trademarks are adequately protected, consider developing an intellectual property portfolio. Often, such a type of consideration applies to legal due diligence. However, in this case, it also overlaps with technical due diligence. 

As an additional measure, consider developing a review of potential infringements on the given intellectual property. Importantly, evaluate the risk of litigation, injunctions, and royalties. Essentially, look at all the correlated aspects that can diminish the value of a company. Pay particular attention to any agreements and documents linked to any other aspect of intellectual property. Working ahead of the timeline ensures you protect your IT assets from an intellectual property side. 

Cybersecurity

One should consider that the technical due diligence team will necessarily evaluate the existing security measures, regulatory compliance, and authorization management within your company and its product. Ensure your company adheres to existing data privacy standards when ensuring decent cybersecurity measures. Check the latest updates on encryption, tokenization, and multi-factor authentication. These measures show that your company and product can protect sensitive data and avoid potential litigation. 

As an additional measure, make sure your employees have undergone and undergo routine security training. Besides, people working for you need to be aware of compliance and engineering prevention. Employees must be trained on techniques for avoiding phishing and data mining. Cybersecurity heavily relies on the human factor, and you should consider anticipating it. 

Management

The final area on the list is management. As a part of the technical due diligence investigation, the team will research various internal processes within your company. As a starting point, there will be a particular focus on examining the organizational chart. It includes checking all full-time employees along with contractors and associated costs. Knowing that in advance, always keep the organizational chart up-to-date. 

What is more, you should consider setting up a database that includes crucial information on all the staff, including their roles, responsibilities, and privileges. Keep all that info updated in real-time. Besides, it is possible interviewers might have some unexpected questions in their arsenal. It is your task to prepare employees in advance. At least higher management, executives, and architects should be able to explain the company’s key values and internal policies. They should also be able to give reasons for particular decisions made previously. 

Finally, have a list of people ready. This list needs to include all the employees and their skills as matched with various parts of the given product. There should be people responsible for the development, operations, and support. With such a list at hand, you’ll be able to envision all the internal operations and have a deep understanding of the startup's organizational structure. You can also share such understanding with everyone who can potentially be interviewed. 

Technical Due Diligence for Startups: The Checklist

After deconstructing all ins and outs of technical due diligence, it is time to offer some quick yet vital insights on what you need to be aware of when the time for TDD comes. The due diligence checklist will be a useful and practical tip for getting the deal all through to the final signing. 

Products and services

When it comes to products and services there are particular aspects to focus on: 

• Cost structure
• Product architecture description
• Deployed and in-development software products
• Customer portfolio/analysis
• Competitor analysis
• Offerings, both current and future ones
• MVP being tested
• Any possible complaints
• Verified warranty claims

Keep an eye on these elements and make sure they are double-checked and prepared before the technical due diligence team arrives.
 

Intellectual property

Never underestimate the role of all the aspects related to intellectual property. To make sure everything is in-tact, collect the following documentation:

• Trademarks, trademark applications, and all trade names
• Patents, patent applications
• Copyrights, both registered and unregistered
• Any licensing for third-party systems
• Collaboration agreements
• Current and pending claims against or by your firm
• IP protection documents
• All revenues linked to patents, trademarks, and copyrights

Keep all these documents together and make sure that an adequate internal investigation was done to make sure nothing escaped your eye. In turn, if something slipped through the fingers, it can result in costly litigation. 

IT assets

Dealing with IT assets is all about collecting documentation of your hardware and software. The long list should include the following:

• Any proprietary software, purchased and leased hardware
• Any cloud platforms, toolkits, open-source software, and licenses
• Insights into system conditions, including aspects like age, support, and usage level
• Any legacy components that need to be replaced
• APIs linking system components
• System quality monitoring tools
• Diagnostics tools
• Third-party agreements
• Software system architecture
• Technology roadmap
• And at least three years' worth of data on budgets for servers and data centers

Collect these documents in advance and have them ready for TDD inspection. Besides, you can talk to different experts to clear the elements you might have missed in the list of IT assets.

Security and compliance

For security and compliance documentation consider the following:

• Data encryption
• Security frameworks
• Controls frameworks
• Authentication instruments
• Events logging
• Intrusion detection modules
• Data backup
• Disaster recovery mechanisms
• Penetration tests
• Cybersecurity audits
• Previous history of data breaches and any cybersecurity incidents
• Compliance with GDPR, HIPAA, and ISO 27001
• Reports on compliance training

The information on these aspects will show that you have decent cybersecurity and that your product can protect users’ sensitive data. 

Human resources

When portraying the state of internal operations, puts emphasis on the following:

• Org chart with all the employees and departments
• Contracted and outsourced employees
• Key employees’ roles and responsibilities
• Costs for full-time and contract employees
• Internal guidelines
• Employee awareness measures
• Primary KPIs for the development team
• Product development workflow
• Software development lifecycle methodologies

These are the core elements that can help any external party understand the complexity of internal operations in your company. 

Final Remarks

The golden rule dictates that technical due diligence stems from detailed preparation. An experienced investor or a contracted due diligence agency knows how to find inconsistencies in any business under investigation. If such is found, the value of your business will diminish quickly and the deal can be potentially renegotiation not in your favor. So, keep tabs on all the documentation correlating to the areas we’ve covered in the article. The key question is whether you can afford to avoid preparing for TDD with the prospect of losing a lucrative deal.