Are We Doing the Right Kind of Tech Due Diligence for Startups?

Takeaways from a Tech Panel at FutureWorldVC in London
By Chris Philipps, Managing Partner at Philipps & Byrne

 

Did you ever ask yourself: Are we doing the right kind of technology and product due diligence on our startups? Many Venture Capitalists are confronted with this question, and the main reason for that is that there really aren’t any clearly defined standards for tech due diligence. What we see  in reality is that TechDD is often based on self-developed procedures, trials and errors, and a somewhat common understanding of best practices. The result of this is that tech due diligence can mean anything from a 30-min call with a CTO from another portfolio company to a 14-day in-depth analysis with industry experts and technicians. So, there clearly is a need among VCs and their target companies to get clarity on whether they are doing the right kind of tech due diligence.

FutureWorldVC: Investors, CTOs, and Tech Advisors Have A lot to Talk About

Zoe Peden, Principal at Ananda Impact Ventures, tapped exactly into this need when inviting the FutureWorldVC community to a panel discussion in London. I was happy to join the panel with Perran Pengelly, CTO and co-founder of DrDoctor and Sara Stephens, CTO and co-founder of Rest Less. It was a perfect setup of VCs, founding CTOs, and technology advisors coming together to exchange ideas and experiences.

On my part, I talked about our approach to TechDD at Philipps & Byrne: What are the objectives, timelines, and deliverables of such a tech assessment? I went into how we work with VCs and startups, and what both sides can and should expect from a proper tech due diligence based on best practices. We also shared some -anonymized- examples of typical red flags or positive impressions. Perran spoke about his experience of working with us and provided some honest reflection of the challenges and positives that came out of the experience. Sara brought in her experience from two TechDDs performed by other service providers and shared super insightful feedback she had gathered from surveying members of the CTO community. These numbers were a great basis for the further discussion among us and with the audience.

Takeaways: What We learned at FutureWorldVC

Despite being a speaker at this event, the exchange with the different participants gave me plenty of fresh input and insights. Also, let’s be honest here: I have been exercising tech due diligence for ten years, and yet we are still trying things out and are keen on finding a better approach for everyone being involved. So for us this was a perfect learning opportunity. Here are some of the things I learned during the conversations with VCs and tech leaders in London:

Investors want clear(er) guidance from Tech experts

Understanding what is going on is of the essence for investors – especially if they do not come from a tech background. Many of the investors – but also the founders – shared their experience of getting a 2-pager TechDD “report” without a clear indication of whether to invest or what to do after the investment.

What they actually want is clear advice on action items, dos and don’ts, next steps, and priorities for both themselves and their target company. There is definitely also a desire for clear benchmarking, rating, and comparability with other investments. In general, investors want tech assessment to be derived from the business context, and how that context translates into tech solutions, set-ups, and processes should be an essential part of the TechDD.

TechDD Findings can be a Conversation Starter for Delicate Topics

One aspect we brought up during the discussion is that the results of a tech due diligence can serve as a well-founded basis to address difficult tech topics on board level. I know from attending board meetings myself, that often slow time to market is being discussed with or without naming Tech issues as a root cause. Having tech assessed by an external expert and going through issues in a structured way is always better than discussing on the basis of a gut feeling or a hunch. Having a structured and honest discussion in the DD phase contributes to more fruitful board meetings with shared expectations clearly set.

Founders and CTOs: Transparency is a Real Game Changer

One of the most interesting findings was brought forward by Sara, who did a survey on two CTO networks. She found out that two-third of founders feel stressed during a technology and product due diligence. But even more important: Apparently there is a direct correlation between stress levels and the degree of transparency regarding the assessment process. In other words: The more transparency, the less stress. As simple as it sounds, the data was impressive:

• Where there was NO transparency on the process, 100% of people were stressed
• With a little transparency, 60% of people were stressed
• With enough transparency, 45% of people were stressed

This begins with having clarity on the deliverables and continues during the assessment itself, all the way to the report. Transparency throughout the entire process makes a real difference.

Secondly, the mode of operation is very important. Here we can see, the more the due diligence is done in a sparring mode, the better. The less this is done, the more useless the experience is conceived by founders and CTOs. Among the CTOs she surveyed, Sara found out that half of respondents felt a TechDD was useful for both investors and founders/CTOs, and half of them felt it was not. This indicates misalignment and inconsistency around the TechDD process and outcomes.

Thirdly, Sara’s survey also found that 80% of TechDD conducted focused on the technology being used in the target company at some point in the process, but only 50% of the tech leaders felt that was actually important. This is an interesting indicator for the business context, often not being considered enough during a TechDD. Meaning, those conducting the assessment are not applying a true 360 degree approach. This channels back to the investors’ desire of tech assessment being derived from the business context.

And finally, and this cannot be overestimated, if the TechDD and the following report provide concrete and actionable guidance for the future, it can function as a long-lasting leverage for tech in discussions with non-tech founders and investors. Perran mentioned in this context that  almost two years later, the engineering leaders in his company still bring up the findings from the TechDD as a gentle reminder for keeping certain standards up. This is what true value derived from a best practice tech due diligence looks like.

Wrap-up: Whether You Do TechDD Right or Not Makes a Huge Difference

So, what can we say about the FutureWorldVC panel wrapping up? First of all, it was a blast! Second, these kinds of dedicated spaces to exchange, learn, and get inspired are so beneficial and valuable, also for us. So many thanks to our client Zoe for putting the whole thing together, as well as to the two post-series-A Tech startup founders, Perran and Sara, and all the participants who so actively contributed to the discussion.

Coming back to the initial question: Are we doing the right kind of tech due diligence? What we see is that whether a tech due diligence is done right or wrong has a great impact on all parties involved. If done wrong, investors lack understanding and visibility, founders and CTOs suffer from enormous stress due to intransparency, and tech advisors have a hard time accessing information and gaining insight, due to a possibly hostile environment. But if done right, meaning with a clearly pre-defined and transparent process according to best practices, TechDD can be the most thorough, honest, and valuable external feedback investors, founders, and CTOs can get. It can provide beneficial findings and actionable recommendations that can help support tech and product strategy and future growth. And last but not least, it can be an important conversation starter between investors and founders about uncomfortable truths that will appear on the board level anyways at some point in time.