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Why mid-market transactions need tech due diligence

Any investment, merger, or acquisition that occurs without thorough technology due diligence is just as bad as any of those transactions without financial due diligence.

Why mid-market transactions need tech due diligence
[Andrey Popov / Adobe Stock]

It is surprising to me how little technology due diligence happens as part of investment, merger, and acquisition transactions, especially in the mid-market. I am surprised because any investment, merger, or acquisition transaction relies heavily on technology for that transaction to make sense from both operational and financial growth perspectives.

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Let’s look deeper into each of these mid-market transaction types and the role that technology should be playing — and, therefore, the importance of technology due diligence.

INVESTMENT

In the case of investment transactions, the fundamental premise is that the company being invested in has the ability to grow and provide the investors a return on the investment. With the current environment, growth isn’t going to come from hiring a bunch more people. Where would those hidden workers come from anyway, given most mid-market companies are struggling to find people?

Growth for mid-market companies almost always means leveraging technology better and becoming more digitally capable. Private equity investors, therefore, have to be aware they are making a technology investment as much as any other kind of investment in a company. Investors have to determine a company’s ability to scale their current technology to perform more efficiently or know what it will take for the company to begin leveraging technology to do so. A company’s technical capacity and capability is what investors of mid-market companies are really investing in (or at least they should be).

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MERGER

Mergers are challenging to make work. The cultures, values, processes, and systems of two companies coming together takes a herculean effort to pull off. Even when it goes well, there is usually a lot of thrashing. Often, the decision is made for certain areas of one company to supersede the other as part of a merger. What is paramount when any two companies attempt to become one is how well the two companies’ processes and systems align and integrate. Two companies that go about the production and delivery of products and services in very different ways likely means the alignment and integration of the two systems is going to be extremely challenging.

I have witnessed merged companies maintain separate processes and systems for decades because neither had systems that could integrate well with the other. When this happens, a significant amount of the value of merging is reduced, and sometimes the merger is totally irrelevant. Companies have to know their level of integration capability before agreeing to merge, as well as what has to happen to integrate or transform systems as part of a merger. Assuming integration will be possible and merging without a plan to do so adequately is a recipe for maintaining disconnected and disparate systems that, in large part, defeats the purpose of merging.

ACQUISITION

Acquisitions happen for a variety of reasons in the mid-market, but one consistent attribute is growth. Acquisitions in the mid-market are about growth for the acquirer—acquiring market share, acquiring a larger team, acquiring new customers, acquiring new lines of business, etc. What often gets overlooked as part of acquisitions is how the growth will impact the company’s technology applications, data infrastructure, and systems.

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An acquisition that doesn’t live up to its potential is often due to a lack of forethought around the technology to support the expanded company. We have many mid-market clients at my firm that, prior to us working with them, had acquired other companies only to realize later that neither company’s technology situation was mature, robust, and scalable enough to support the combined company.

So, what does a technology due diligence look like? There are seven primary areas of focus for technology due diligence:

1. Architecture, technology stack, and infrastructure: Is it proper, does it support the needs of the business, and can growth be supported?

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2. Data: Everything from governance to data repositories and systems.

3. Applications: Has a company implemented or developed the right applications, and is it using them effectively?

4. Security: Are a company’s systems, applications, and data appropriately secure?

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5. Processes: Does a company have established processes around systems, applications, releases, documentation, and code?

6. Integrations: How integrated are a company’s systems and applications, and how prepared are they to integrate with others?

7. People: Do they have the right people in the right seats?

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Any investment, merger, or acquisition that occurs without thorough technology due diligence is just as bad as any of those transactions without financial due diligence. Private equity investors and companies that are part of mergers and acquisitions should be investing as much in technology due diligence as they are in any other form of due diligence. The needed growth as part of these transactions will surely be dependent on the technical horsepower of the companies involved.


Ryan Frederick is a Principal at the technology consulting firm AWH (www.awh.net). 

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