What You Need to Know about Technical Due Diligence before Buying an Online Business

When buying an online business, it’s critical to understand the business’s technical details before closing the deal. Therefore, the technical due diligence process serves an important role in shedding light on key elements so you can make an informed investment decision. 

In this article, we discuss several topics relating to technical due diligence, including:

• What technical due diligence is
• Why technical due diligence is important
• How to conduct technical due diligence

What Is Technical Due Diligence?

You may be wondering, “What is technical due diligence?” First, let’s get clear on what exactly this term means. 

“During technical due diligence, the buyer has the opportunity to verify all technical components of the business.”

Technical due diligence defined

There are many steps to purchasing a business. First, the buyer locates a target company that appears to fit their needs. After that, the buyer and seller have the opportunity to negotiate a tentative deal. Once the buyer and seller negotiate a deal, they enter into a due-diligence process.  

Before finalizing the transaction, it is important for the buyer to verify all of the information pertaining to the business. This is their opportunity to ensure they are making an informed decision and buying the business as the seller has represented it.

One aspect of the due-diligence process is to ensure the technical condition of the business is sound. This process is known as technical due diligence. 

During technical due diligence, the buyer has the opportunity to verify all technical components of the business. This may include:

• Technical infrastructure and architecture
• Code quality
• IT staff
• Technical operations and processes
• Security

This is not an exhaustive list. In addition, each of these components can be broken down into more specific tasks. 

Given its complexity and importance, many buyers (or sellers, as we will see) choose to hire a third-party technical due-diligence team. These professionals are highly trained and experienced in providing technical due-diligence services. 

This allows them to provide a well-informed and reliable assessment of the technical state of the acquisition target. 

“Before finalizing the transaction, it is important for the buyer to verify all of the information pertaining to the business.”

The difference between technical due diligence and other forms of due diligence

It is important to note that technical due diligence is one aspect of the larger due-diligence process. While technical due diligence focuses primarily on analyzing the technical side of a business, it does not cover other important aspects. 

As such, you may hear people talk about legal due diligence, commercial due diligence, or financial due diligence. Each of these processes focuses on separate but equally important aspects of verifying a business’s health. Taken together, all of these processes fall under the larger due-diligence umbrella. In practice, they are often carried out simultaneously. 

In addition, technical due diligence and other areas of due diligence, such as legal due diligence, sometimes overlap. We will discuss this further below. 

The Importance of Technical Due Diligence

The technical due-diligence process is one of the most important stages of a successful acquisition. There are many reasons why it is helpful, including:

• Verifying the technical components of a company to identify strengths and weaknesses
• Assessing risks
• Forecasting future performance
• Preparing a company and employees for a sale
• Avoiding disputes and legal troubles after a sale

“By exploring the technical components of a business, the buyer can identify the business’s strengths and weaknesses.”

Verifying the technical components of a company to identify strengths and weaknesses

As we discussed, the process allows the buyer to verify that all of the seller’s claims about their company’s technical aspects are true and accurate. This is important because it allows the buyer to have a high level of confidence that they are getting the business they think they are. 

By exploring the technical components of a business, the buyer can identify the business’s strengths and weaknesses. This enables them to negotiate the final price and terms more effectively as well as plan for the future of the business more accurately. 

Assessing risks

By becoming familiar with the technical components of a business, a buyer can better assess the risks the business entails. Assessing risk is a crucial part of deciding whether a given business is a worthwhile investment opportunity. 

For example, let’s say you (or your team) are assessing the code structure of a SaaS business. During the assessment, you determine the code is written in such a way that makes it more susceptible to being hacked, thus making it less secure. 

Obviously, this discovery reveals an area of technical risk within the business. Armed with this knowledge, you may decide you do not want to move forward with the deal. Or, if you don’t want to pull out entirely, it could allow you to negotiate a lower price or more favorable deal terms with the seller.  

“By becoming familiar with the technical components of a business, a buyer can better assess the risks the business entails.”

Forecasting future performance

The knowledge you gain from due diligence may allow you to better forecast the company’s future performance. Depending on the technical strategy the company employs, you may have a better idea of whether or not you can expect the company to grow, stagnate, or decline moving forward.

Preparing your company for the market

So far, we have discussed the importance of technical due diligence from the perspective of the buyer. However, sellers can benefit immensely as well. 

Many sellers choose to have a third-party company conduct technical due diligence prior to bringing their company to market. By doing it early, the seller gains valuable information that can help them optimize the company in order to receive a higher sales price. In addition, it can allow the seller to take steps to create a more streamlined and successful selling process. 

By conducting technical due diligence prior to listing, the seller gains a better understanding of the strengths and weaknesses of their company. They can then use this information to address areas of weakness and highlight the company’s strengths when presenting the business to interested buyers. 

In addition, it can also help prepare employees to be interviewed by a prospective buyer during the transaction process. This, along with addressing other issues, helps to remove issues and roadblocks that would otherwise get in the way of a smooth transaction. 

“Conducting technical due diligence helps ensure all parties have full knowledge of the business prior to closing. This allows the buyer and seller to minimize opportunities for disagreement later on.”

Avoiding disputes and legal troubles after closing

Neither the buyer nor the seller wants to encounter troubles or disputes after a sale has been finalized. But if due diligence is neglected and the seller is blindsided by a surprise after they take over ownership, issues can arise. 

Conducting technical due diligence helps ensure all parties have full knowledge of the business prior to closing. This allows the buyer and seller to minimize opportunities for disagreement later on. 

How to Conduct Technical Due Diligence

Now that we know what technical due diligence is and why it is important for both buyers and sellers, let’s take a closer look at exactly what the technical due-diligence process entails. Many entrepreneurs find it helpful to create a technical due-diligence checklist to help ensure a smooth process. 

Components of technical due diligence

There are many individual components of the technical due-diligence process. These components, in turn, can be grouped into several larger categories. These include:

• Codebase and third-party software check
• Current and future product road map
• Technology review and explanation
• Intellectual property review
• Review of company structure and individual roles

Below, we will review each of these categories in more detail.

Codebase and third-party software check

Depending on the nature of the company, it is important to do a thorough review of the codebase used in the development process. This may be very important for some types of companies that have a software product, such as a SaaS business, and less relevant for others. For example, if you are looking at purchasing a simple Amazon business, this stage may be more limited. 

In conjunction with analyzing the codebase, it is important to verify all third-party software the business uses. When doing so, it is helpful to create documentation about the relationship between different programs, source code, metadata, and all necessary licenses. In essence, you are conducting a review of the software architecture of the company.

By performing the above actions, the buyer assures themselves that they have met regulatory compliance. In addition, it allows them to verify the health and effectiveness of all relevant code and software. 

“In conjunction with analyzing the codebase, it is important to verify all third-party software the business uses.”

Technology review and explanation

Similarly, it is important to conduct a thorough review of all technology and engineering systems not already covered in the code and software check. Think of this as ensuring the company framework or scaffolding is adequate. 

This review would likely examine aspects of the business such as:

• Engineering organizational structure and technology integrations
• Security infrastructure
• Data centers
• Open source components
• Database management systems
• Programming languages

This information is helpful to the buyer as it allows them to gain an understanding of how the tech is set up. It also gives perspective on what it would take to run the company after taking over ownership.

It may also allow them to determine whether the company is prepared for growth from a technology standpoint. If it isn’t, the buyer would be more aware of what it would take to create scalability within the company.

In the case of one company taking over another, it also provides a clear picture of what it would take to create a seamless merging of the two companies’ technology ecosystems. 

Current and future product road map

It is also important to analyze the technical components of the products the company currently has as well as any products under development. This endeavor may blur the lines between technical due diligence and commercial due diligence. Given that certain products have a technical component, however, it is important to list this step here. 

When analyzing current and future products, be sure to pay attention to how the products stand out from the competition. In addition, it is important to note the revenue that can be attributed to each product. Lastly, it is helpful to assess the scalability of each product. Part of this requires you to assess the market as a whole, including potential barriers to entry and expected market trends.

This will allow you to create a product roadmap. Documenting the product road map will help you conceptualize the expected future performance of the company and its products.

Intellectual property review

Conducting an intellectual property review falls under both legal due diligence and technical due diligence. As such, it is helpful to include it as part of the technical due-diligence responsibilities. 

When conducting an intellectual property review, it is important to note the patents of the company in question. It is also important to assess the likelihood of the company’s patents infringing on competitors’ patents. Failure to adequately do so raises the potential risk of encountering legal disputes with competing companies down the road. 

“It is necessary to assess and review the overall structure of the company. In addition, the review should note the individual roles specific employees play.”

Review of company structure and individual roles

Lastly, it is necessary to assess and review the overall structure of the company. In addition, the review should note the individual roles specific employees play. It should also note any professional services that third-party vendors provide. This allows the buyer to determine how effectively the company structure is set up. It also helps to identify potential redundancies in the workforce. 

When reviewing a company’s structure, it is helpful to create a chart showing all of the roles and how they relate to each other. If you are the seller, you can create a smoother due-diligence process by clearly documenting this information before selling.