Red Flags: What Should Investors Look Out For In a Tech Deal?
In a tech deal, Software Due Diligence aims to identify red flags that signal the possibility of setbacks or financial loss.
To shed some light on the matter, we asked Avalia: What red flags should investors look out for in a tech deal?
Their answers touch on some of the complexities investors face in tech deals, and a common thread running through them is that red flags are often not where you’d expect to find them.
Every case is different, but one area that can raise a red flag in any tech deal is people.
Most tech transactions are about speed: faster scaling, faster mastery of a technology, quicker delivery of new products, or quicker entry into new markets. However, scaling, building, and maintaining systems are not mechanical tasks, and the people who do them are not easily replaceable.
Software development is, in most cases, creative work reliant on the tacit knowledge of the people who do it. If these people have already left or leave shortly after the deal is closed, due to cultural or technical mismatches, for example, then most if not all of the speed the deal was expected to deliver will likely be lost. Worse still, the risk is not evenly distributed across people, so its assessment requires a fine-grained approach.
Determining who the key people are requires diving deep into the technology: how it was built, its current state, and where it needs to be to deliver on the investment thesis.
It is not uncommon for people essential to executing the post-deal plan to leave during or shortly after a closing. In one case, our data analysis during the software due diligence revealed the risk of losing a key engineer; but, by the time she was approached, after the deal had been closed, it was too late.
“The good news is that organisations have the data necessary to provide the trained eye with a clear picture of the key-people risks and actions required to ensure a successful deal is closed.” — Rodney Reis
In another case, we used machine learning to identify the pattern of developer departures and predict who was most likely to leave so the company could address them proactively and improve their talent retention during the due diligence phase.
Ultimately, other critical risks such as scalability, security, and ability to execute, to name a few, are all impacted by the knowledge and skills required to do the job. Investing in technology without thoroughly understanding the team involved is a risk and should, in itself, be a red flag.
The good news is organisations have the necessary data, from software development systems, to provide the trained eye with clues about the right questions to ask to get a clear picture of the risks and actions required to ensure a successful deal is closed.
Rodney Reis, Avalia Co-Founder and CEO with over 20 years of experience creating successful businesses, leading highly-skilled teams, and delivering sustainable growth internationally.
It is relatively simple to understand the basic principles of computer programming and to take the first steps in software development, but those who are active in the field know that the production and operation of professional software is one of the most complex endeavours ever performed by humans.
The evolution of technology only increases the complexity around software, which is why problems or bugs can be difficult to find, especially because some can lie dormant and occur sporadically.
“Software problems or bugs will always arise, so not being prepared to tackle them is a big red flag.” — John Forman
The point is not to guarantee that the software is problem-free, which is practically impossible, but to ensure that the teams responsible have the necessary tools, knowledge, maturity, and processes to face the problems and solve them in the best way possible.
Problems will always arise, so not being prepared to tackle them is a big red flag.
John Lemos Forman, Avalia Business Director and senior consultant in innovation and digital transformation with over 30 years of experience in business management and consulting for tech-based companies.
In terms of technology, a typical red flag we have encountered is a situation where a company finds itself in a position where it is impossible or very difficult to upgrade or update one or several tools and/or the underlying technology of their software and infrastructure.
“Tools and technologies falling out of their maintenance window often induce critical security vulnerabilities.” — Guillaume Serneels
There could be several reasons for this: lack of expertise in the technological domain, lack of resources, software incompatibilities between components or persistence tools, or hardware incompatibilities.
This situation can become highly problematic as tools and technologies falling out of their maintenance window often induce critical security vulnerabilities. It may also represent a concern in terms of attractiveness, as a company relying on outdated technologies is less likely to attract new talent.
Guillaume Serneels, Avalia Software & Data Engineer with over 5 years experience in software engineering, full-stack development, data integration, and interactive data visualisation creation.
When acquirers consider merging a target’s technology or products into their portfolio, the incentives for the deal, broadly speaking, are usually based on the identified opportunities for scaling.
So, it’s vital to identify the key aspects that made the target stand out and to establish whether their organisational elements like culture, leadership, processes, and engineering practices are well-rooted, so they can support the expected growth.
“Inconsistencies or mismatches in organisational elements like culture, leadership, processes, and engineering practices can be red flags.” — Anderson Soffa
Potential red flags related to this might be inconsistencies in the way things are built or the terminology used by various stakeholders, process mismatches, different approaches to problem-solving, or inconsistent support for metrics like OKRs at different levels of the organisation.
To simplify the complex, it all comes down to discovering the key differentiators and finding out how they can be maintained and scaled after a deal, as well as discovering missing fundamentals and downplayed or misidentified risks.
Anderson Soffa, Avalia Technical Director and software engineering expert with over 20 years of experience in software engineering, modernisation of large-scale legacy systems, and Agile adoption in large and mid-size organizations.
A red flag isn’t always about the size of a problem in the product’s architecture or development processes, but it’s cost: How much will it cost and how long will it take to fix?
“Red flags aren’t always about the size of a problem, but their cost to fix - in time and money.” — Fernando Viegas
Fernando Viegas, Avalia Technical Director and Software Engineering Expert with over 20 years of experience in software engineering, full-stack development, database optimisation, cloud infra, and agile development.
How can data-driven software due diligence make a difference?
Many technical due diligence processes will only scratch the surface of the complexity involved in a tech deal.
This is why Avalia has focused on assembling a team with proven software engineering and business expertise, employing machine learning and leading-edge research, and developing an in-house platform and toolset.
Beyond surface-level technical due diligence, Avalia takes a data-driven approach to uncover red flags in all the elements that impact the technology's development, evolution, and maintenance, covering the product, processes, and people in depth.
In complex and fast-paced tech deals, Software Due Diligence is indispensable.
For clear, actionable insights that focus on business impact, count on Avalia in your next tech deal.