What It's Like To Go Through Technical Due Diligence

Over the years, my software development organizations have been subjected to due diligence conducted by private equity firms prior to agreeing to invest in the companies I was a part of. I thought it would be helpful to go over the types of topics they investigated before deciding whether we were investable. For their sake, I will not disclose who conducted the due diligence or for which companies it was conducted.

Firstly, who does the due diligence? While it could be conducted internally, there are companies that specialize in software technology due diligence. Their job is to meticulously examine your organization to identify any potential risks that might be lurking. While their specific methodologies are often proprietary, they all generally include various code scans, document reviews, and interviews of staff within the organization. Although some companies often specialize in only one or two aspect of the due diligence process.

This analysis is to help the investing or acquiring company understand what investments might be needed to bring a potential company up to your standards or align it with your business plan. The culmination of this investigation is usually a detailed written report, which you, as the target of the due diligence, may or may not ever be allowed to see.

Product Analysis

During the due diligence process, firms meticulously investigate various aspects of a software company to gauge its potential for success, risk factors, and overall viability. The scope of this investigation encompasses a broad range of topics, each critical to understanding the company's technical foundation and market positioning. Here's a detailed breakdown of the areas typically explored:

1. Product Overview: This initial assessment focuses on each product offered by the company, detailing its functionality, programming languages, target audience, vision for the future and how it fits into the company's broader product strategy. This includes identifying common components such as identity providers or other custom code bases that are maintained across products. Even standalone applications, like APIs, are thoroughly described and evaluated for their integration and contribution to the overall product ecosystem.
2. Architecture Quality: A deep dive into the software's architecture is conducted to assess its design and structure. This includes evaluating the software's ability to meet current and future business requirements, its adherence to best practices in software development, and the use of technologies that ensure longevity and robustness.
3. Scalability: The investigation also examines how well the applications can handle growth in terms of user base, data volume, and transaction frequency. This encompasses the software's architecture and infrastructure's capacity to expand without compromising performance or requiring significant redesigns.
4. Extensibility: Firms analyze how easily new features can be added to the application without disrupting existing functionality. This involves reviewing the software's design and codebase for modularity, use of plugins, or other mechanisms that facilitate seamless enhancements.
5. Integration Capability: The ease with which the application can be integrated with other systems and technologies is scrutinized. This includes looking at the availability and documentation of APIs, compatibility with standard data exchange formats, and adherence to industry protocols.
6. Reliability: This aspect focuses on the software's uptime, consistency in performance, and its ability to recover from failures. Factors such as error handling, redundancy, and backup mechanisms are evaluated to determine the software's robustness.
7. Security: The due diligence process places a high priority on assessing the application's security posture. This involves examining the software for vulnerabilities, the implementation of security protocols, data encryption methods, and compliance with relevant regulations and standards.

Each of these areas may be accompanied by a score and a comprehensive analysis that provides a detailed look into the strengths, weaknesses, and potential areas for improvement. This thorough examination aids investors in making informed decisions and helps software companies understand where they stand in terms of technical capabilities and market readiness.

Code Quality Analysis

In addition to evaluating the broader aspects of a software company's offerings and technology, due diligence processes also place a significant emphasis on a detailed analysis of the software's codebase. This scrutiny is crucial for understanding the technical health, maintainability, and future-proofing of the product. Here’s an outline of the key areas involved in the process analysis:

1. Coding Practices: This assessment focuses on the standards and methodologies adopted by the development team. It evaluates whether the coding practices align with industry best practices, including code readability, use of design patterns, and adherence to coding guidelines that ensure maintainability and scalability.
2. Code Structure: A deep dive into the organization of the codebase, examining how logically and efficiently the code is structured. This includes looking at the modularization of the code, the separation of concerns, and the overall design that supports ease of maintenance and extension.
3. Code Duplication: Identifies areas of redundancy within the codebase, where identical or similar code blocks are repeated. High levels of duplication can indicate potential for consolidation, which can reduce maintenance efforts and improve code quality.
4. Understandability: Assesses how easily new developers can comprehend the code. This involves evaluating the clarity of code comments, documentation, and overall code readability. Understandable code is crucial for effective team collaboration and future development efforts.
5. Completeness: This aspect looks for indicators of incomplete or in-progress work, often highlighted by TODO comments or similar annotations. Analyzing these can provide insight into the development team's workflow, potential bottlenecks, and areas that may require further attention.
6. Cyclomatic Complexity: Measures the complexity of the software’s code structure by counting the number of linearly independent paths through the program’s source code. Lower complexity is preferable for easier testing and maintenance.
7. Defect Analysis: Involves identifying and evaluating bugs or defects in the code. This can be accomplished through automated tools or manual review processes. The analysis helps in understanding the current quality of the product and areas that need improvement.
8. License Analysis: Especially critical for software that incorporates open-source components, this analysis reviews the licenses under which code is used or distributed. Particular attention is paid to open-source and copyleft licenses to ensure compliance and to assess any potential legal obligations or restrictions on the use or distribution of the software.

Each of these areas can be graded, often based on the results from code analysis tools designed to detect "code smells" and other indicators of potential issues, though manual code reviews also play a vital part. This thorough analysis aids in identifying not only the present state of the codebase but also in highlighting areas for improvement, ensuring the software is built on a solid foundation.

Team Analysis

The team analysis is an integral part of the due diligence process, as the capabilities and structure of the team are crucial for the sustained success and growth of a software company. This evaluation provides insight into the organization's human capital, identifying both strengths and areas that may require further development or restructuring. Here's how the team analysis is typically conducted:

1. Overview of Positions and Their Roles and Responsibilities: This part of the analysis categorizes and reviews the different roles within the company, focusing on key positions rather than individuals. It examines the responsibilities associated with each role, such as the Chief Technology Officer (CTO), software architects, Software Development Engineers in Test (SDET), developers, and other critical technical and managerial positions. Understanding the distribution of roles and responsibilities helps in assessing whether the team has the necessary breadth and depth of skills to meet its current and future objectives.
2. Outsourced Overview: The due diligence process extends beyond the internal operations of a software company to include a comprehensive analysis of outsourced vendors, their geographical locations, and the rigor with which they enforce security and process standards. This evaluation is crucial in understanding the risks and dependencies associated with third-party engagements. It involves scrutinizing the vendors’ operational practices, their commitment to security protocols, and their adherence to industry best practices. Particular attention is paid to how these vendors manage data privacy, ensure service continuity, and comply with relevant regulatory requirements. The geographical location of vendors is also considered, as it can impact data sovereignty, latency issues, and the ability to provide timely support. This aspect of due diligence ensures that a company's reliance on outsourced services does not compromise its operational integrity, security posture, or compliance with global standards, thereby safeguarding the company’s assets and reputation in a globally connected ecosystem.
3. Overview of Critical Resources: Identifying critical resources involves pinpointing individuals or teams whose knowledge, skills, or leadership are essential for the company's operations. This goes beyond mere role identification to evaluate the impact of these key players on the company's workflow, product development, and overall success. It's about recognizing those whose absence would significantly disrupt operations or project timelines, thereby highlighting potential vulnerabilities in team composition and knowledge distribution.
4. Analysis of Open and Future Positions: This component assesses both current vacancies and positions planned for the future, offering a snapshot of the company's growth strategy and its ability to attract talent. An examination of how well positions have been historically filled provides insight into the company's attractiveness as an employer, the effectiveness of its recruitment processes, and potential challenges in scaling the team. This analysis not only reflects on the company's reputation in the job market but also on its capability to evolve and adapt to changing market demands or technological advancements.

Together, these aspects of team analysis paint a comprehensive picture of the human element within the software company. They highlight the organizational structure, the strategic alignment of roles and responsibilities with company goals, the reliance on key individuals, and the company's readiness for future challenges through planned expansions or strategic hires. This evaluation is crucial for understanding the operational dynamics of the company and its potential for sustainable growth and innovation.

Process Analysis

The process analysis within due diligence meticulously evaluates the operational and procedural frameworks of a software company. Each critical component is scrutinized and potentially scored to quantitatively assess the company's efficiency, effectiveness, and procedural maturity. Here is a detailed enumeration of these components:

1. Process Engineering: This evaluates the methodologies and practices for accomplishing work, including how processes are defined, documented, and adhered to across the organization. It assesses the consistency, quality, and scalability of the output, considering both the presence and quality of documented processes.
2. Requirement Management: Focuses on how the company captures, documents, and tracks requirements throughout the project lifecycle. Effective requirement management ensures the final product meets intended use cases and customer needs, also considering the management of requirement changes.
3. Project Management: Examines planning, execution, and monitoring of projects. This includes the use of project management tools, adherence to timelines and budgets, risk management practices, and the effectiveness of stakeholder communication.
4. Design Process: Reviews procedures and standards for software design, from initial concept to final design stages. It considers the software's user interface and user experience design, as well as the architectural design, for alignment with product strategy and user needs.
5. Development Standards: Evaluates coding conventions, code review practices, management of code smells, security coding standards, and the monitoring and enforcement of these standards. This is crucial for maintaining a high-quality, secure, and maintainable codebase.
6. QA Testing: Looks into QA testing practices to understand how software quality is assured. This encompasses strategies for manual and automated testing, test planning, test case management, and the integration of QA throughout the development lifecycle.
7. Software Configuration Management: Assesses how changes to software configurations are managed, including code, documentation, and other artifacts. Effective SCM practices are essential for maintaining integrity and traceability of software versions, managing branches, and facilitating team collaboration.

Like before, each area can be scored based on criteria such as comprehensiveness, maturity, and effectiveness. These scores provide a measurable way to compare operational strengths and weaknesses, offering insights that can significantly influence investment decisions by highlighting a company's procedural rigor and its potential for sustained success.

Infrastructure & Operations Analysis

The due diligence analysis of operations and infrastructure examines the foundational systems and practices that ensure the reliability, security, and scalability of a software company's services. This analysis provides insights into how well-prepared the company is to handle current and future operational challenges. The components of this analysis, often scored for thorough evaluation, include:

1. Hosting Overview: Reviews the architecture and strategy behind the hosting of all cloud, outsourced, and self-hosted components, as well as any critical Software as a Service (SaaS) integrations. This assessment aims to understand the rationale behind hosting decisions, the diversity and reliability of hosting environments, and the integration depth with essential SaaS solutions.
2. Hosting Security: Evaluates the security measures and protocols in place across hosting environments. This includes data encryption, network security practices, access controls, and compliance with relevant security standards and regulations.
3. Monitoring and Alerting: Assesses the systems and processes for monitoring the health, performance, and security of the infrastructure. This includes the comprehensiveness of monitoring coverage, the effectiveness of alerting mechanisms, and the ability to proactively address potential issues before they impact users.
4. Capacity Planning: Examines how the company anticipates and manages scaling needs for its infrastructure. This involves understanding the processes for forecasting demand, evaluating current capacity, and implementing scalable solutions to accommodate growth while maintaining performance and reliability.
5. Backing Up and Restoring: Reviews the strategies and practices for data backup and restoration to ensure business continuity. This includes the frequency of backups, the security of backup data, the effectiveness of restoration procedures, and the ability to quickly recover from data loss incidents.
6. Disaster Recovery: Evaluates the plans and capabilities for recovering from significant disruptions, such as natural disasters, cyber-attacks, or major system failures. This includes the existence of a formal disaster recovery plan, the regular testing of this plan, and the strategies for minimizing downtime and data loss in the event of a disaster.

Each of these operational and infrastructure components is crucial for the sustained success and resilience of a software company. Scoring these areas provides a quantitative measure of the company's operational maturity and readiness to manage and mitigate risks associated with its technological infrastructure.

Estimates

The due diligence report often extends into the realm of forward-looking assessments, providing estimates that are crucial for informed decision-making by the acquiring or investing company. These estimates encompass a variety of operational, technical, and strategic areas, offering a comprehensive view of potential future expenditures and investments required. Key areas where estimates are particularly valuable include:

1. Completion Costs for Critical Features: An evaluation of the company's projections regarding the costs to complete certain critical features. This involves verifying the accuracy of the company's estimates and potentially adjusting them based on the due diligence findings, ensuring a realistic understanding of future development expenses.
2. Standardization Costs: The report may include estimates for the costs associated with bringing the company's code, security practices, and operational processes up to the standards of the acquiring or investing entity. This covers everything from code refactoring and security enhancements to process re-engineering, highlighting the investments needed to achieve desired levels of operational efficiency and security posture.
3. Business Model Implementation Costs: Estimates to implement the intended business model given the current resources. This analysis is crucial in a build vs. buy vs. acquire scenario, helping to quantify the financial implications of each option and guiding strategic decisions based on the most cost-effective and resource-efficient pathway.
4. Future Cost Analysis: A forward-looking assessment that might include the cost to address scalability issues, technical debt, or other uncovered challenges in order to meet intended revenue goals. This part of the report anticipates the financial impact of necessary technical improvements or expansions, providing a foundation for strategic planning and budgeting.
5. Management Queries: The report may also respond to specific questions from management intended to clarify the potential costs and benefits of the investment or acquisition. This could encompass a wide range of inquiries, from the cost implications of entering new markets to the financial feasibility of integrating the acquired company's technology with existing products.

These estimates play a pivotal role in the due diligence process, equipping the acquiring or investing company's management with the financial insights needed to make well-informed decisions. By thoroughly examining these aspects, the due diligence report sheds light on the anticipated investments required and the potential return on those investments, thereby informing the overall strategy regarding the acquisition or investment.

Conclusion

Concluding a comprehensive due diligence process can indeed be a daunting experience, even for those at the helm of a well-orchestrated organization. However, it's essential to recognize the invaluable insights that such an in-depth examination offers. The due diligence process, with its thorough analysis of every operational facet—from your team's composition and processes to your software's architecture and security—provides a unique opportunity to view your company through an external lens. This perspective can uncover areas for improvement that might not have been apparent from the inside.

When the process concludes, if you're presented with the due diligence report, it's crucial to approach it with an open mind. If you're granted access to this report, use it as a tool for refinement and growth rather than perceiving it as a critique of your team's efforts or a personal affront. The findings and recommendations outlined in the report can serve as a roadmap for elevating your operations to new heights, identifying not just weaknesses but also underscoring strengths that you can build upon.

Embrace the insights gleaned from the due diligence process to foster a culture of continuous improvement within your organization. By doing so, you not only enhance your company's operational efficiency and product quality but also position your team for future success and resilience in the ever-evolving business landscape. Remember, the goal of due diligence is not to criticize but to illuminate pathways to excellence.