The art of building software: Why perform technical due diligence prior to an acquisition?

Wednesday, September 22, 2010

Why perform technical due diligence prior to an acquisition?

Michael Sisco put it well I think: "Conducting thorough [technical] due diligence can make the difference between a successful merger and a company's collapse."

If you're a high tech company looking to acquire another high tech company, please perform technical due diligence as part of negotiating the deal, ideally prior to signing a term sheet.  Here's what could happen if you don't.

First, you won't understand the costs, timeline, and resources required for delivering the promised integration of the newly acquired company.

Second, you won't have a good understanding of who to keep and who (if anyone) to let go as part of a Reduction In Force (RIF).  You won't be able to develop a new organizational structure because you haven't worked out what you're going to do and in what order.

Third, there is some value in the technology of the acquired company.  The value is significantly correlated with the quality of the code and architecture, and whether you have to rewrite the product code or not.  This should figure into the overall acquisition cost negotiation.

Fourth, you won't be able to optimize your own product development schedules to account for the possibility of the coming acquisition.  It's often possible to re-order development tasks to intelligently account for the possibility of the coming acquisition, without incurring cost if the acquisition falls apart.  Or you might pause or slow-roll hiring certain roles until you know how things are going to shake out.

There is always time to perform technical due diligence.  More information is always helpful.  For smaller companies, you can usually do the whole thing in a week.  Get the book Technology Due Diligence if you don't know how and want to do it yourself.  If you don't have the time or skills to do it yourself, you can hire a firm like blackduck to do the technical due diligence for you.

Since I manage the Chief Technology Officer Exchange over on LinkedIn, I asked some CTOs what they thought of the practice of investing in or acquiring other companies without performing technical due diligence.  Here is one response I find particularly interesting from a CEO in the group:
This kind of acquisition is a lot more common than it used to be. I'm seeing a growing number of companies decide they don't have to worry too much about moving software forward from its current state. That leads them to conclude they can do all sorts of things that seem like bad practices. Acquiring without diligence is one. Not taking care of the developer team is another. 
I haven't seen much evidence that these formulas are successful, it's just that I'm seeing companies try them more often. 
Another surprising one is for VC's to invest without proper technical diligence. This happens pretty often and has been going on a long time. They get stung by it periodically.
In general, most non-developer types have no real idea how to manage, value, or evaluate IP assets.

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