On a recent podcast, Crosslake CEO Barr Blanton shared insights on preparing for tech due diligence. Referencing Crosslake’s experience on thousands of prior private equity transactions, Barr explains the process of tech diligence and its importance to investors. Throughout this discussion, he shares:
- The investor’s perspective of balancing risk and value with compliance requirements
- Insights on navigating the dynamics between buyers and sellers
- An explanation of the complementary roles between technical diligence and other diligence workstreams
- Crosslake’s approach for tailoring tech diligence to each unique buyer and investment strategy
- Recommendations for target companies preparing for tech due diligence
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A few highlights from Barr:
On what investors are looking for during tech due diligence:
“They’ve got three things in their head: One is: what is the risk I would be undertaking here? Two: how much value can I create for the price that I pay? And three is more compliance oriented: as a firm, am I checking all the boxes that I need to check to ensure that I can get the proper coverage or insurance or pass my investment committee?”
On a common misconception around tech due diligence:
“This is not intended to be a gotcha exercise. By the time a tech due diligence is initiated, both parties (in most cases) already have an affinity for one another. There’s mutual interest there. There’s an investment thesis or an interest from the business that the investor will add value.
“So while there is the bottoms-up view of validating claims, in many cases, it’s actually just trying to create a transparent set of facts so that both parties share a common understanding. From there, both the investor and the management team can begin thinking about the key questions they need to align on post-investment to create value together.”
On the type of businesses that require a tech due diligence:
“To some degree, every business is a tech business at this point. The complexity of their back office systems and how those fuel their business may be the scope of tech diligence. There are also tech-enabled services businesses or tech-enabled businesses. These are businesses that do something else besides software or pure technology. In many cases, they sell a service, but they’ve actually built a piece of proprietary software that makes their business better and differentiates them from their competitors. So they may also be building software. It’s rare at this point to find a business — at least in the world in which we play — that hasn’t gone out and built its own software to some degree. And so getting an understanding of what it is and how it creates value in the business and how it’ll continue to create value in the business is really our remit.”
On how Crosslake approaches tech due diligence:
“What we’re trying to do is prioritize our time so that we’re creating the highest level of understanding or the best level of understanding against the key areas our client cares the most about. Having done more than 3,500 tech due diligences in the last few years, there is a pattern recognition that does not draw conclusions, but gives you fertile understanding of where to dive deeper. You begin to understand where things don’t necessarily add up or where you want to spend more time to make sure you understand and can assess a risk or an opportunity appropriately. It’s about getting aligned with the client on what are the most important risk and value-oriented lenses they’re focused on.
“And then recognizing that there’s no perfect business, there’s no perfect tech. And so it’s the pragmatic, relative judgment that’s really important here. Our job is not to assess: is this perfect? Our job is to assess whether this meets your needs from a risk and value perspective. Does this seem like a viable investment based on what you want to do with the business?”
On how businesses should prepare for the tech due diligence process:
“We work with management teams one to two years out to think about the questions that a buy-side advisor may ask of them. Put yourself in an investor’s shoes and think about what you would want to know about your business. Think about the documentation and materials that might be relevant. In a technology sense, that might be architectural diagrams, product roadmaps and the like. Start to get some of those together in almost a pre-data room construct.
Beyond that, consider how you’ll be getting your broader team engaged. Different management teams take different approaches, but the earlier you can get the broader team involved, usually the better. You want them to think from the same lens about how to ready the business.
And I would recommend reaching out to advisors in the space. They’re always happy to just have a conversation and help you consider the five questions that buyers are most likely to ask, and therefore, how to get ready. While the approach varies a little bit by business and by strategy, it’s a rapid process. It is a unique process, but it actually can be a really engaging and insightful process. It’s your chance to shine. It’s your chance to tell your story about the next chapter of your business. And I think when firms approach it that way, it can be a really engaging process.”
About the podcast: Hosted by Mike Baliman, the London Fintech Podcast is a popular 30-minute weekly show that launched in 2014. It features interviews with key players in finance technology and is the longest running podcast of its kind in Europe, boasting global reach.