Technical Due Diligence, Looking for More than Just Cool

man-suit-light-bulbDue diligence is the research and analysis done in preparation for a business transaction. Due diligence is most often associated with financial analysis but also comprises review of products, markets, legal status, operations and more. Those interested in dealing with technology companies must also require research and analysis on the technology as part of due diligence. For the evaluation of technology start ups, performing technical due diligence is of major importance and is often under served.

By way of example, I was working with a late-stage start up that was considering an acquisition of another start up that had, what they claimed, was a disruptive technology for the same market. The second start up presented their technology and road map. It looked interesting, but the roadmap represented a huge leap in assumptions. The potential acquirer then sent the VP of engineering and two engineers to evaluate the technology at the second start up's offices. They came back with a verbal summary of what they found and some good stories about the bars in that city. No report was written and no further documentation was provided by the second start up.

This example is extreme in how poorly technical due diligence was conducted and reported. It is, however, instructive because the scope of technical due diligence performed was on par with what many companies, and some investors, perform before striking a deal with a technology start up. There is much more due diligence to be performed to adequately evaluate a technology. Consider these topics as the basic scope for technical due diligence:

Are There People Who Understand the Technology?

The inherently-greatest technology in the world is of no use if there is no one who can leverage it for a product or service. In performing due diligence, particularly with a new or nascent technology (graphene comes to mind), special attention must be made as to whether personnel is available to develop solutions with it. Perhaps even more important is whether there are people available who are smart enough to progress the technology beyond the current solution. Finally, there is the need to evaluate if those people are able to interact in a business environment, such as in cross-functional teams, to develop a solution for scalable business.

Is Documentation and Process Information Available?

How did they build the Great Pyramids? No one knows for sure. Without documentation and process surrounding a technology, there is a high risk of failure in successfully managing or replicating that technology. People come and go. If the technology is not formally documented and processes codified, the potential exists to lose significant value. This was exemplified to me in discussions with a specialty manufacturing company that had been purchased from an individual founder by a private equity firm. The company had a market advantage in its tool making capability. However, that capability was based in the skill and knowledge of one individual. In addition to demonstrating the value of that person to the company, the new leadership made it a priority to institutionalize and document his knowledge and ability, to preserve it and reduce the company's risk profile.

Is the Technology Scalable?

Scale is the difference between a start up and long-term business viability. Scale is also the difference between a cool technology prototype and a full-scale production solution. If the technology cannot be physically scaled to the capacity or capability required, then it remains only a curiosity. Without proof of that scalability from the due diligence process, the risk profile of the technology must be considered to be high.

Is the Technology Production-worthy?

Should due diligence show the technology to be scalable, the next question becomes, is it producible? Can it be produced in volumes necessary for successful business and at acceptable quality? Are parts and materials available? Are manufacturing capabilities available? Production worthiness differs from scale in that technology may scale but remain impossible to produce in a cost-effective (price-effective) manner. A technology that cannot be produced at market volumes at an acceptable cost/price point may be worth watching but is likely not worth investment.

What is the Intellectual Property Profile?

Technical due diligence often includes evaluation of patents (pending) and other intellectual property (IP) associated with a technology. This is very important, particularly to the valuation of a start up. However, the flip side of the IP question may be even more important. Does the technology potentially infringe on a patent owned by another company, worse yet a competitor? Or if it does not infringe, will its use be limited by the intellectual property of others? Even if a patent is seminal to the technology, its usage may be blocked by other patents in the field. If, for example, a company patented an improved touch screen for the iPhone it does not give them the right to use iPhone patents to produce their own phone.

Is the Technology Relevant?

Technology that enables personal moon landers, no matter how cool, is not relevant because you can't live there and you can't get back. Similarly, technology that enables a t-shirt to never wear out, but that costs $1,000,000 per shirt isn't going to get far versus simply buying $5 t-shirts. Cool technologies are not always relevant. This element of technical due diligence reaches a bit into the realm of market opportunity due diligence, but deserves some thought by those performing technical due diligence. Asking the simple question about relevance may save a lot of time and money.

Does the Technology have Runway?

Technical due diligence should consider the runway of the technology. Does it support a one-off product or solution, or is it foundational to an array of solutions? Neither answer is inherently right or wrong. The answer is relevant to the expectations and roadmap of the business or investor performing the analysis. For example, a technology that may enable vast opportunities, that is evaluated for only a limited opportunity, will certainly be undervalued by the assessor. This low value will make an acquisition unlikely, but may allow for a license deal for the limited business opportunity. In the same case an investor may find the technology investment opportunity more valuable because of upside potential from new business opportunities or from the technology asset itself.

Does the Technology Have a Durable Timeline?

A durable timeline for a technology relates to its relevance, production worthiness and runway, but is worth mentioning as a stand-alone consideration. Most technologies have a roadmap associated with them, a path from the basic or nascent technology to something better or more expansive. Often the validity of this roadmap is necessary to the acceptability of the technology as currently presented. In short, the value offered is really in the roadmap. Therefore the due diligence on the technology really becomes due diligence on the validity of the roadmap and, assuming that it is a rationale leap from current technology to projected technology, one of ensuring that the timeline for that transformation is reasonable. If the business or investment has time constraints, and the roadmap timeline is questionable, then the technology is high risk.



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