The journey of building a startup is far from easy. Once you have an idea, test it through an early prototype, you move to the minimum viable product stage. You want to garner that crucial investment that will help you realize this big thing you once dreamt of while sipping coffee.
But as investors get interested in your brainchild, you may need to pass the biggest of all hurdles: technical due diligence. Technical due diligence happens once an investor decides to acquire or invest in a technology company.
Related: Equity Crowdfunding vs. Venture Capital: Which is Best for Your Startup
Once they make that decision, they have a small window of time to ensure that the company stands on firm ground- its technology, people, processes and speed are what they seem from the outside.
What is Technical Due Diligence?
Since investing in or acquiring a company is complex, it warrants a holistic due diligence investigation. As part of the process, you help prospective investors analyze your product, architecture, processes and frameworks inside out.
Whether you are preparing for an M&A or investment from a VC firm, the other party will want to go deeper into the happenings of your company.
They will want to be sure that their investment will not go down- meaning you will need to prove that you are worth their bucks.
What is the need for Technical Due Diligence?
Investors carry out technical due diligence for various purposes:
When investors want to join a startup, they are usually interested in finding cash leaks, technology risks and anything that is a wasted cost.
Why is it important for startups?
As a bonus for startup owners, they get to discover and improve on their weaknesses through the due diligence process. In fast-paced startups, changes are so frequent and unpredictable that founders will often go astray from the concept that got them started.
Technical due diligence helps clarify that the existing product and business model follow the initial idea and inspiration. Besides, technical due diligence may prove to be a blessing in disguise for startups set for success as it gives an investor instant insight into your business to fall in love with your company.
One thing is for sure- you will learn a lot about your own company through this process- both the good and the bad.
What does the process look like?
The process of due diligence may vary based on the stakeholders involved. But here are the most important steps that rarely miss out.
To begin the process, the development team or the outsourced vendor conduct an extensive code review. It includes analysis for errors, anomalies and general missouts in the programming style.
At this stage, developers conduct a documentation review, verify the code for integrations, components and other solutions, identify strengths, plan for weakness coverage and prioritize issues to address later.
Don’t make the mistake of attempting to work on the weaknesses part on the day of preparation. That may do you more harm than good.
A kick-off call officially starts the technical due diligence process. At this stage, the startup stakeholders and investors need to build a trust-based relationship and vow to complete the process with honesty and transparency.
Related: Your Guide to Investor Outreach for Startup Fundraising
This call identifies the due diligence stages, finalizes the timeline and lays down the roadmap for the process. Next, the CEO delivers the product vision, concept, target audience, value proposition and anything else as an introduction to their company.
Few folks enjoy documenting, but it plays a strong role here. At this stage, the investor or their hired representative will examine all of your existing documentation. The more you have, the better.
The list includes architecture overview, processes, backup and recovery procedures, monitoring processes, servers and development frameworks.
Analysts will perform an in-depth screening of these documents before the next step.
The party carrying out the due diligence conducts an in-person meeting to review and explore the information they already have. They primarily wish to interact with the product owner.
This meeting lasts a couple of days at the most. The analyst studies parts of the product in real-time and aims to understand the value for customers and the logic behind each decision made throughout the product’s lifecycle.
Often after an extensive study of the product, the investors have questions. Any clarifications and answers are delivered within the frame of 1-2 follow-up sessions.
Be sure to answer all accumulated questions diligently for the investor’s satisfaction.
The result of the process is a detailed report that objectively highlights all pros and cons of the product and the business. It encloses the overall judgment about your product and company and how promising they look.
The report is sent to the startup stakeholders. The report is also shared with the investors if the investors engaged independent specialists to carry out the due diligence.
The scope of Technical Due Diligence for startups
The scope of technical due diligence may vary from case to case. But here are a few pointers that rarely miss the list. Preparing for due diligence involves an act of balance – highlighting your strong areas while also accepting the weak links.
Due Diligence processes also differ by the stage of investment you’re at. At the Seed stage, the process focuses on potential as you’re building the product. In the A/B/C stage, when the focus is on expansion and growth, investors are more interested in the product’s ability to scale and attract customers.
In the C or D stage of investment, however, it’s all about product maturity and exit planning.
Having clarified that, let’s look at the various components of the technical due diligence process.
In this component of the technical due diligence, startups present their technology for investors through architectural charts, documentation, performance metrics and APIs documents. We advise companies to also research the underlying infrastructure of their competitors to make a strong case of why theirs is superior architecture.
Moreover, besides opening up your product architecture for the investor, explain why you decided to build your product the way you did. Answer why you chose the particular technology for app servers, databases, programming languages and other similar questions.
Also, enlist the third-party tools and open-source software used in your product and justify your choices over the numerous other options.
Pointers to go over:
During technical due diligence, investors are particularly vigilant of the code quality to foresee any heavy developmental changes in the product resulting from poorly written code. Badly written code can cause heavy technical debt or maintenance costs to an organization down the line.
Therefore, investors assess product code from both operational and financial aspects. Here are a few pointers to take care of:
All startups wish to grow and expand, but unfortunately, most aren’t built for it. Sooner or later, they crumble under the pressure of expansion because of two core reasons- either the technology underlying the product isn’t designed for scalability or the stakeholders find it hard to run and manage an expansive team.
Therefore, consider those two areas and try to answer this objectively- are you built for scalability?
If you find areas where you could do better, consider the cost of building for scalability now.
People and teams
An extensive technical due diligence won’t happen without including people. No matter how cutting-edge your product is, if there aren’t competent and willing people supporting your growth, failure is inevitable.
Investors know this, so they will want to look at your organizational chart- your employees, their roles and even your outsourced service providers, remote contractors and other vendors.
Have an updated version of your organizational hierarchy along with a database of each employee’s position, role description, salary and skills. Also, consider the future. Are there skill gaps that you wish to hire for soon?
Here are a few pointers to consider:
Workflows and processes
Those conducting technical due diligence will certainly want to peek behind the curtains and assess how you carry out operations. These include development iterations, security testing processes, deployment, maintenance, codependencies and quality assurance.
Documentation can again be your strong suit in this regard. Here are a few pointers to work on:
Security breaches and hacks cost companies thousands of dollars every year. Small businesses and startups are also under the same threat today. This is why investors will always want to know the security posture of your product.
To be sure of your product’s security, you can hire an outsourced security assessment company to analyze your product and uncover vulnerabilities without biases. Here are a few things to consider when preparing for this aspect:
IP & licenses
Some experts perceive intellectual property and licenses to be important assets. Be sure to show the strength and uniqueness of your product by presenting the patents that protect your IP and proof that you didn’t infringe on anyone else’s IP rights.
Another important aspect of this component is the third-party tools, both free and open-source ones. Be sure to update your patents regularly and track all third-party components to prevent any legal hassles in the future.
As part of the due diligence, investors will surely look at how your technology supports your vision for your company and product. Create a document that highlights everything in your tech stack, including all software products used in your product, besides the programming languages and external APIs integrated into it.
Here, too, the focus may be on the security and scalability of all moving parts in your product. Have you built for the long-term? Your technology stack will reflect the answer to that question.
Support & maintenance
Your product will inevitably run into issues, and that calls for a robust structure for the maintenance and support of the product. Review the user support history to evaluate issues and create a roadmap to improve the user experience.
Honestly reveal all user support issues encountered so far and how they have been addressed or are in the process of being fixed.
Tips to carry out successful Technical Due Diligence
Now that we’ve seen what technical due diligence entails, here are our top three tips for you to nail this.
Do a dry run
Engage third-party consultants to perform due diligence for you just as your investors might. This way, you can unearth possible issues before going for fundraising.
Don’t fake it
A huge red flag for investors during the due diligence can be when you pose your company, product or yourself as something you’re not. Honesty is really the best policy here.
Prepare for the typical and the unexpected
Prepare and foresee the typical questions you will get by saving or printing this article for future reference. Also, ask yourself the possible unexpected questions your investors may have about your company.
Step into their shoes and figure out anything else you may need to work on.
We created this holistic article to help you figure out your next steps and strategy for technical due diligence. However, if you want experts on your side, contact us today and we will assist you with anything you need related to technical due diligence.