When buying a startup, investors focus on the product, the capital structure, competitors and the monetization strategy. More and more, however, potential acquirers are adding IT due diligence to their due diligence efforts.
When considering the technology environment at a startup, savvy investors understand that they won’t see the same processes that Amazon or IBM have implemented. And, given that they’re most likely buying the idea, the team, the intellectual property or the customers, they probably won’t concern themselves with things like an inventory of your laptops or a copy of your BYOD policy. They’re going to be focused on the most important technology and product issues.
This article discusses some of the IT due diligence issues most likely to trip up a deal involving a startup.
Scalability and Performance Testing
If the buyer wants your product, they’ll almost certainly have a plan to significantly increase the user base. Could your product handle ten or even a thousand times your current number of users without being re-architected? Be ready to demonstrate that you’ve planned for scalability from the start, either through your design or better yet from the load testing you’ve performed.
Proper Software Licensing
Don’t take shortcuts on software licensing.
While it might be tempting to use unlicensed software, it will be identified during IT due diligence and this is a great way to have your deal price lowered. The investor will have to determine how much it might cost to properly license whatever you might need going forward, and will probably add on some percentage as an “uncertainty factor,” since they’ll wonder what else might come up later that they don’t know about. This assumes that the deal isn’t killed because the investor is worried about your decision-making or honesty.
Investors will want to know about any security or hacking incidents you’ve experienced. If you’ve had any, they’ll want to understand exactly what happened and what you’ve done to make sure it won’t happen again. They need a comfort level that you understand the importance of security, especially if your startup is in an industry such as healthcare or finance. In those fields, a huge fine or a fatal blow to your reputation can be only one security breach away.
You’ll most likely be asked to document and describe any system downtime in the past six or twelve months. What has been done to ensure that the problem won’t reoccur? Downtime can be a result of any number of issues, such as lack of scalability, underpowered hardware, uncoordinated release management or poor testing. Everyone has downtime – remember when Twitter was fairly new? Be sure you can isolate the reason it happened, communicate what you learned and explain how you addressed the underlying cause.
Intellectual Property Ownership
It’s very common to find that companies don’t own all of what they consider to be “their” software. This is often a result of utilizing non-employees to do some development. If you used contractors or consultants to develop any part of your product, have an attorney review the agreement you had with the developer to determine who owns the rights to what they created. You might be surprised to find that even though you paid them for the work, you don’t own it. If you didn’t have an agreement, you should ask an attorney what that means about your ownership rights, and address the situation as needed. Otherwise, you may find yourself in the midst of a deal, trying to fix the problem as your investor’s concern increases by the hour.
The team at your startup may well be your greatest asset. In fact, sometimes the investor is buying the company to get the team. Be sure that everyone the investor interviews is presentable, professional and gives the appearance of working well together. This isn’t always easy at a technology startup, but if the investor feels like the founders can no longer stand working with each other, or you have too many employees on the wrong side of eccentric, they may think twice about writing that check.
Expect a source code review. You know your code and your product. You know where the weak spots are. If you were reviewing your company’s code, what would concern you? Someone who’s an expert in your preferred development language will be doing the review, so address anything that you know you wouldn’t want to see if the roles were reversed.
If you make sure you have the issues listed above addressed in a solid way before trying to sell your company or attract investors, it should go a long way towards making sure your startup clears the IT due diligence process without incident.