Over the past several years we’ve performed multiple due diligence inspections of software companies and seen the output of other due diligence activities. We’ve also been through acquisitions and observed multiple software companies post-acquisition and let me tell you, doing due diligence on a small software company is difficult.
Firstly, let’s discard the concept of “strategic acquisitions”. This is merely a euphemism for paying too much. Strategic acquisitions rarely deliver the anticipated value. No matter how closely aligned to your strategy another company may appear, the software architecture and building blocks will almost never fit seamlessly into your existing solution set, and the culture and way of doing business will be different enough to create organizational stress. This is just a given.
In general, you are buying a software company for the customer base, market opportunity, and the solution. You are not just buying a set of assets, you are buying value creation capacity. The solution is a mix of the software, the team, and the way of doing business – we call this Process, People and Product. All three have combined to create the company you are now planning to buy, and to foster the customer relationships that represent the revenue being generated.
The classic technical due diligence focuses on things like Open Source licensing, automated code scans, scalability concerns, source code commenting, intellectual property agreements, etc.. These are all important (well maybe not as much for source code commenting), but for most acquirers they are not where the bulk of your risk is. The questions you need the answers to fall into two categories:
Business Continuity
The baseline for the acquisition is to be able to service the current customers (keep the current revenue flowing in), and the maintain the current rate of closing new business (meet the most conservative predictions). If you can do this, then you have managed to get what is a valuable commodity in any acquisition – time.
Due Diligence must provide you something to assess your risks in this area.
- What if my CTO quits?
- What if the lead developer asks you to double their salary?
- Is there a defect backlog that means my customers are going to be showing up with pitchforks and torches?
- If my servers crash, can I still build and deliver?
- How often are there serious issues, and who is able to fix them?
If you don’t have the experience in executing a software business you might not know the questions to ask – so due diligence must highlight the risks allowing you to take appropriate action.
Alignment with the Strategic Vision
While you will (try to) price the acquisition based on the current state of the business, nearly every acquisition anticipates an up-side. Examples we run into include:
- Expanded Sales whether by a VAR channel or new geographies
- Changing the business model to SAAS and delivering on the cloud
- Going up market to large customers
- Leveraging large customer successes in the SMB space
- Increasing the amount of customization services performed
Each of these implies features and capabilities in the overall solution – product, process, and people. Due diligence has to provide you the metrics and conclusions to assess how realistic your strategic vision is – or how much money and time you will have to invest to get there.
The “one size fits all” approach to due diligence that we often see focuses on source code metrics and industry standard processes – and often fails to give you actionable information in an understandable form.
What you need is your own CTO with a proven track record of building software businesses and delivering to referenceable customers to act as a trusted partner in the process. You need someone to take the time to understand why you are making the acquisition, your near and long terms goals, your appetite for risk, and the culture you bring. Only then can the technical due diligence be anything more than a tick in the box on your due diligence checklist.
If you’re an investor or entrepreneur looking to acquire a software business, let us work alongside you as your trusted partner to properly assess not only any risks but the potential as well.