7 Ways Investors Can Gain Clarity While Conducting Technical Due Diligence
It feels like almost any company is a tech company in one way or another these days. But when it comes to assessing investment opportunities, few venture and growth equity investors have the resources to conduct thorough technical diligence.
They often outsource this critical work to a consultant for more of a high-level overview, because technical diligence is often a blind spot for investors. This should not be the case, as the robustness of a product or its lack thereof can make or break a company.
The focus of diligence tends to be on aspects of a product that can be measured. As a result, the emphasis is often around financial performance, drilling down to detailed metrics such as gross margins, sales rep productivity, LTV, CAC, payback periods and more. While sales and marketing spend is often the largest operating expense for a high-growth business — sometimes representing over 40% of revenue — R&D costs can also be material, typically comprising more than 20% of revenue.
However, the assessment of the product and R&D expense base is more of a qualitative assessment based on discussions with management, industry analysts and experts, customers and partners. Investors are not alone in feeling somewhat uncomfortable about this. Even CEOs who don’t have an engineering background are forced to rely on the CTO and product team to understand the scalability of the code, technical debt, the cost and time to develop product roadmaps, and more, without a quantitative way to assess the performance.
Over time, technology should become less of a black box for investors.
Lacking knowledge of the code or the product’s evolution, we are just scratching the surface, which makes us more vulnerable to technology overhauls along the way.
The following seven tips will help you gain more clarity on a company’s technology and how best to prioritize initiatives over time for the product to be clearly differentiated in the market.
Getting the tech architecture to scale is critical
The initial decision on which tech architecture to use is widely underestimated, and not enough young companies realize the long-term ramifications.
This is the foundation the code is built on, and it needs to be aligned with the company’s go-to-market strategy. Lack of planning upfront can lead to costly code rewrites later on, and significant customer issues.
Recognize the power of a great developer
I would rather have one A+ developer than 10 B players. While this is true for many other roles, too, it really hits home in an engineering organization.
One of my favorite lines from a technology executive is that nine women cannot make a baby in a month. Throwing bodies at a product to quickly develop it is often not the answer, and can compound the problem of technical debt.
It’s important to take the time to make the right hires. Remote work is here to stay, and access to great talent has now been vastly expanded.
Discipline and process matter
Young companies often develop a product without a clear view of what the customer wants. This is where the product management function comes in. This is not a luxury to have; it is an absolute necessity.
A good product management process will coordinate with customers, prospects and development to ensure there is a good product road map in place that aligns with the strategy. It will help ensure that there is good documentation of the tech specs and functionality.
With this, the organization can assess the time and costs to execute against the roadmap and subsequently measure performance against this plan. This analysis can provide great insight into the process and what can be improved.
One of the primary reasons companies fail is that they have not proven there is product-market fit. Strong product management helps lower the chances of this happening. You can have the best product, but that doesn’t matter if there is no market.
The caliber of the engineering team and culture of the organization is very important. Has the team been together for some time and developed a good chemistry? Does the team work well across the company or operate in silos? Has there been lots of employee turnover? Does the company have the right level of software DNA and agility needed to succeed?
People make businesses, and it is the team that will position the company to build great products and execute the business strategy.
The “not invented here syndrome”
There are many good technologies in the market that engineering teams can use to lower time to market. Despite this, companies often find themselves building such capabilities from scratch rather than leveraging what already exists and focusing on their core differentiators.
This is where build versus buy/partner decisions are critical. Understand what is unique to the business and continue to build on that secret sauce.
Additionally, beware of complete overhauls when recruiting a new CTO and/or VP of Engineering. While such a new hire may be critical, it can also result in rewriting history in cases where only some honing is needed to optimize the situation.
Listen to the customer
Reference calls with current, churned and potential customers will provide invaluable perspective on the product. How was the implementation process? Has the product been broadly adopted by the key users? Are they raving about the offering? What could be improved? Is there a consistent, repeatable use case to build a big business upon?
These are just some of the many questions that you could ask customers. While concerns will likely be heard, the key is that management acknowledges deficiencies and has a clear action plan to address them. The business should have a customer success team to get ahead of issues before the risk of churn becomes high.
Go deep on what really matters, and contact experts in the sector. Pick the one or two areas that will be critical to scale the business instead of boiling the ocean on tech specifications and observations.
Find the right expert to help identify and assess the risks and merits of the product. If you find yourself using the same expert across different investment opportunities, you may be taking the generalist approach too often.
Ongoing cyber tech assessments should be scheduled to protect against vulnerabilities. It only takes one incident compromising customer data to sink a business.
Over time, technology should become less of a black box for investors. There is a wave of emerging companies developing products to make technology more measurable and drive strategic alignment within an organization. Use these to your full benefit.