Technical Due Diligence: A Complete Guide for Startups and Investors

Technical due diligence has become a crucial gateway to the success or failure of business deals because it is a fast paced business environment marked by acquisitions of technologies and venture capital. Such an overall evaluation process assists in discovering possible risks, proves the technological capabilities and ascertainments that investments are made in ventures that have substantial technical backgrounds. According to the latest statistics in the industry, the sobering fact is that about 90 percent of startups permanently fail, and 10 percent of these fail to make it through the first year. Most of these collapses are as a result of missed technical flaws which could have been detected and countermeasures taken with appropriate due diligence procedures. In the case of startup founders, technical due diligence is a chance to show that their technology is scalable, and it can also withstand serious examination of the prospective investors or acquirers. It is an important risk assessment tool to the investors and buyers, enabling them to make appropriate decisions on where to invest their resources.

Technical due diligence is an all-encompassing due diligence process involving the inspection of the technology infrastructure, software applications, and IT capacity in a company. This analysis extends beyond the functionality that is visible to the eye, and looks into the internals of the architecture, security, scaling capabilities and the state of the technical health of the organization. It is carried out through the analysis of the relationship between various technological elements, possible weak points, and the potential to determine whether the existing technology stack will be able to sustain the future development and business goals. Technical due diligence is used during mergers, acquisitions, or investment round to make the stakeholders know the strengths and weaknesses of the technology used by the target company.

The main goal of the technical due diligence is to determine the possible risks and to assess the way they will affect the business processes and the future developmental opportunities. Such an assessment is insightful to the stakeholders and gives an objective analysis of the technical capacity of a company. Routine analysis usually touches on some of the most important areas:

Code Reviews

Code review This is a close inspection of software quality, performance indicators and maintainability in the long run. In cases where the codebase of a given platform demonstrates disorganization or duplication of patterns, usually known as so-called code smells, then this is a sign that the development was in haste or that there was a lack of care applied when it comes to quality. These problems can have serious effects on the future development speed and reliability of the systems. The quality of code can be used to indicate that there are problems with the development process and that the costs of maintenance will increase and the technical debt may rise in the long run.

Security Checks

Security tests check the capability of the system to stop, identify and react to different security threats and vulnerabilities. This is especially important with applications where sensitive user information is being processed or workings in a regulated sector. To illustrate the point, in case of security reviews, the evaluators may learn that the security was vulnerable to SQL injections or that the site does not perform sufficient data encryption. Early knowledge of these weaknesses can eliminate the possibility of security breaches and the reputation loss that can follow.

Scalability Assessment

Scalability assessment is aimed on how the system will be able to cope with the growth and an increase in operational requirements. This involves testing the response of the technology to the sudden increase in the traffic, the rise of traffic volume, or the growth of the number of users. Failure to plan the scalability of the system may cause the system to crash at the time of peak load causing customer dissatisfaction and even loss of revenue. The awareness of the limitations of scalability enables the stakeholders to plan infrastructure investments and architectural additions.

Software Development Reviews

This element analyzes the process and procedures utilized during the software development life cycle including an initial planning phase, a development phase, and a deployment and maintenance stage. When a platform has bugs every time a new release is issued, it can be a sign that the testing process is not well-developed, or that there is not enough quality assurance. These problems have direct effects on the timelines of product delivery and experience among the users. The issues with the development process can also be due to the technical debt, which has been accrued due to shortage and fast fixes, and has resulted in maintenance issues in the long run.

There are several business cases when technical due diligence is required:

• Before acquiring or investing in a technical startup: Due diligence helps to understand how the platform of the startup can process high user volumes and which security vulnerabilities, in turn, can directly affect the decision to invest in this project.
• Regarding collaboration with fellow technological companies: Technical analysis assists in knowing the potential partner and their technological incompatibilities, which may include ineffective use of old programming languages that might affect joint ventures.
• When raising a round of financing or having a merger: In case your startup is about to make an investment, due diligence can help to pinpoint and fix the technological bottlenecks so that your business can portray itself in the most favorable light to your potential financiers.

The technical due diligence is usually conducted by:

Third-Party Firms

External vendors who are specialists in software architecture, infrastructure, and security are usually desired to offer unbiased evaluations. The third-party vendors introduce new cross-industry knowledge and may deliver an in-depth analysis with specific recommendations that can be taken to counteract the weaknesses identified. This is an external view, which assists organizations to establish more robust, scalable technological bases to ensure sustainable growth.

Technical due diligence is a process that has to be carefully planned, executed, and detailed. As software engineers, we know that assessment must do a thorough evaluation to identify the strengths as well as possible vulnerability of the technical systems. The process is usually done in a series of related steps:

Pre-assessment

The first step is the orientation in the current technical environment before proceeding into the more detailed analysis. This is the stage when a broad amount of knowledge is obtained on the products, technology stack, market position and market competition of the company. The pre-assessment sets the parameters of all the other assessment processes and gives the evaluators a baseline of the technology know-how, namely what the technology is, how it works, as well as its place in the overall business ecosystem. This is the base knowledge that determines the course and orientation of the rest of the due diligence undertakings.

Code review and architecture analysis

After pre-assessment, evaluators do intensive scans of code quality, codebase structure and technology stack structure. The acute analysis of architectural decisions, scalability, maintainability, and reliability measures, and security implementation practices are involved in this stage. The code review and architecture test gives the idea of the health of the product in terms of technology and its further scalability and development.

On-site technical inspection

Once preliminary tests are conducted, a thorough study of the entire technology ecosystem of the startup will also be required. Although it is always possible to visit the sites, remote inspections have gained more and more popularity and efficacy in the digital era. Technical experts look into a variety of factors such as system architecture, codebase structure, security implementations, deployment processes, and testing processes. This is aimed at making sure that the technology can be in line with the best practices in the industry as well as be able to adjust to the highly unstable technological environments.

Interpretation of technical documentation

Technical documentation quality is also a major factor in the assessment of a venture in case of mergers and acquisitions. This is done by looking at system architecture designs, testing plans, product specifications, user manuals and intellectual property documentation. Extensive documentation will also prove organizational maturity and operational preparedness and poor documentation can question system maintainability and knowledge transfer proficiencies.

Measuring development practices and processes

This stage measures the methodology used by the organization in development, approaches to project management, version control systems as well as code review processes. It is also the evaluators who look into key performance indicators and quality metrics. This is to make sure that the development processes are always regular, steady and agile in order to meet the future requirements and challenges without compromising on quality of deliverable.

Tech stack market alignment

The last assessment aspect is to ensure that technology decisions are in line with the available industry trends and standards. This analysis looks at how the product can keep up with technological changes and whether technical decisions will sustain future growth and expansion plans. This is an important analysis to determine any threats that can be caused by the technology obsolescence and to make sure the technical base is capable of supporting long-term business goals.

Organizations that are planning to go through a technical due diligence are always concerned about which areas will be considered. In order to give light on methodology and areas of focus, we have formulated an all inclusive technical due diligence checklist. The nine areas reviewed are of a critical nature and the following areas include infrastructure, platforms, software architecture, coding standards and quality, security measures, dependencies, scalability, operational processes, and team capabilities and structure. All the elements give information on various facets of the technological prowess and expansion of an organization.

Infrastructure

Infrastructure is the infrastructure digital backbone that is the basis of all other technological operations. Infrastructure analysis gives information about system robustness, potential reliability and scalability. Some of the important infrastructure features are:

• Network architecture
• Implementations of cloud services
• Data backup policies
• Disaster recovery systems

These elements uncover the general strength and soundness of the digital infrastructure.

Platforms

Platform evaluation analyzes the place of deployment and use- e.g. web applications, mobile platforms, and desktop environments. The study on the analysis of platform-specific constraints, technological flexibility, and feature applications demonstrate efficiency of the product in general. This analysis also gives hints at the viability of the future growth in various technologies and platforms. Contract platform-specific developers or consultants to provide the best platform performance and support expansion in the future using various technologies.

Software architecture

Software architecture analysis gives a complete picture of the aspects of system design, flexibility and maintainability. These features are essential in supporting the changes, integrations, and evolution of the system in the future. Architecture should be well-designed to enable long-term business value by increasing adaptability and minimizing maintenance overhead. The idea is to consider employing a software architect that will evaluate and enhance system design, flexibility, and long-term business value maintainability.

Coding standards & quality

Code quality assessment checks the readability, modularity, reusability and compliance with the standard code practices. These aspects give hints on the health of software and its maintainability. Technical debt or lack of code quality may be an indicator of high future maintenance cost and cost to fix issues in the future. Introduce senior developers or code experts, who will review and improve the quality of code, decreasing technical debt and improving the overall quality of software.

Security measures

The current threat environment In the contemporary digital threat environment, an extensive security assessment is an important part of due diligence. Security protocol assessment assists in revealing the possible vulnerabilities and averting security compromise in the future. Strong security systems ensure trust of the users, avoid data breach and organizational image. Hire cybersecurity specialists to examine security controls, detect weaknesses, and make amends to safeguard organizational image and user confidence.

Dependencies

Dependency analysis identifies the third-party libraries, external services, and API integrations to identify the licensing compliance issues and risks. This analysis offers the understanding of integration viability and long-term influence of common technology stacks. Dependency knowledge can be used to determine possible risks associated with the reliability of external services and the licensing requirements. Use software licensing experts to ensure that there is compliance with third-party libraries, services, and APIs to reduce the risk factor.

Scalability

System scalability is an important parameter to consider both in the ability to grow and the ability to sustain more operations. Analysis of load control capacities and data expansion processing effectiveness assists in establishing whether technology is capable of dealing with future expansion. Scalability testing is done to ascertain that the systems can support business expansion without scaling back the performance. Consult performance engineers or scaling skills to make sure that the technology can support future growth needs and can support a higher demand.

Operational processes

Operational process evaluation offers an insight into technology management practices on a day to day basis. Investigation of deployment processes, release processes, error logging processes, and resolution processes can identify inefficiencies, which affect productivity and revenue. The operational processes are streamlined to facilitate the delivery of consistency and reliability of the system. Contract DevOps specialists to automate deployment pipelines, release processes and enhance error resolution processes.

Team capabilities & structure

Team capabilities have a direct effect on technology stack performance and sustainability. The expert and competent teams are a source of competitive advantage, operational flexibility and the capacity to satisfy the current and upcoming technological needs. Technical teams are powerful in terms of maintenance of systems, developing features, and keeping up with the ever-changing requirements. It is possible to consider the engagement of DevOps professionals/process consultants to examine and streamline deployment, release, and error handling workflows.

Preparation Before exploring the technical due diligence audit, it can appear to be a daunting task, however, by concentrating on key matters, the process can be dramatically better. Below are the crucial areas to be focused in your organization:

• Make sure that your technical infrastructure can scale, grow, and adapt to the requirements of future growth and change in the market.
• Code on high standards to reduce technical debt and to ensure product sustainability.
• Prioritize cybersecurity practices and adhere to the set standards and best practices of security practices.
• Share technical skills and duties among your team members so that you do not become overdependent on team members.

Non-technical considerations

Technical due diligence is impossible without a thorough grasp of the business environment in which you are operating. Organizations do not all have internal technical expertise to carry out rigorous technical audits. When your current team does not have specialized technical skills or is at capacity, then an external consulting team can be utilized to offer important new expertise and optimization advice. The final intention is not just to be able to pass the due diligence process but to be able to come out a stronger company technologically and capable of a sustainable growth and an agile one at that.

Technical due diligence is not an easy task, especially when it comes to startups. Even though the emerging companies possess innovative ideas and have great motivation, they are faced with challenges during this critical assessment stage. The following are the main reasons why startups can fail in the technical due diligence:

Insufficient technical documentation

Due to the urgency to create products and achieve market fast, full technical documentation can be put aside. Nevertheless, the lack of documentation is a major red flag during the technical due diligence. Lack of documentation casts doubt on the sustainability of technology, maintenance processes and scalability or interoperability of the system with other platforms.

Absence of a scalable infrastructure

Startups have a valid reason to get their ideas operational in the short run, which often leaves them without the consideration of building systems to support future expansions. Technical due diligence involves showing long-term vision and scaling with expansion of the company. Inability to show adaptability and scalability may seriously affect the results of evaluation and investor trust.

Inappropriate code quality

Market pressure may encourage compromises in the development process, and thus, not optimal code quality is achieved. Nevertheless, coding standards, discontinuous practices or a large amount of technical debt casts tremendous doubts on the future of maintenance costs and the reliability of the system in question. These challenges might be major contributors to due diligence failures, and it might need to spend a lot of resources to resolve them.

Lack of security protocols

Cybersecurity is a crucial element of technology-intensive enterprise. In some cases, the startup overestimates the security requirements, which can lead to vulnerabilities that may have a devastating effect on the results of technical due diligence. Lack of proper security or adherence to standard security practices may severely curtail the success of a start up in the process of evaluation.

Reliance on critical members

Startups are also known to be dependent on limited people when it comes to technological expertise. In cases whereby technical knowledge cannot be transferred or shared among the team, it poses dangers that may raise eyebrows among prospective investors. Excess dependency on certain people may create a major influence on the appraisal of a startup and sustainability in the long term.

Underestimating the non-technical components

Even though technology is the centre-stage, non-technical factors including user experience, timeliness, and customer feedback are important determinants of product success. Ignoring these factors in the name of technical aspects alone can reflect the lack of business knowledge. This short sight can serve as a cause of technical due diligence issues and can be a symptom of a lack of market knowledge.

Faith of experienced developers

Lack of budget may compel start up to recruit less experienced developers to work on the product. Code quality problems and bad development practices could be the outcome of this decision and be revealed in the course of technical due diligence. Once such problems are uncovered, prospective investors are likely to doubt the competency of the company in terms of technology and its overall competence. Under these circumstances, the in-depth software audits are necessary to determine and remedy the issue of concern.