What Exactly is Technical Due Diligence for a Startup?
by Vlad Pavlov and Robert Garza
In a context of venture investment, Due Diligence (DD) is defined as “the process by which investors explore a company that they are thinking of investing in” (see Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist). Another way of looking at DD is “making sure what you are buying is what you think it is” (see Scientific due diligence: A handbook for investigators and investors).
During the DD process a VC would usually assess a startup’s leadership team, check the company’s technology and IP, verify customer demand, analyze competitive landscape, take a close look at the company’s financials, check bylaws, contacts and licenses, debate an exit strategy, as well as other checks (see Leaders Wanted: Making Startup Deals Happen: Advanced Techniques in Deal Leadership and Due Diligence for Early Stage Investors).
Technical Due Diligence (TDD) is just one of the steps in DD. It includes checking the company’s technology and Intellectual Property (IP), and usually has two components: legal and engineering.
- Legal component (L-TDD) normally includes legal a audit of the company’s patents, copyrights, trademarks, trade secrets, etc. (see Intellectual Property and Technology Due Diligence)
- Engineering component (E-TDD) requires an R&D expert to assess the company’s technological capabilities. Frequently, it is only this component which is called TDD (TDD in a narrow sense).
There are different ways to approach E-TDD. In our opinion, it has to answer three main questions:
- Where is the company on the FITYMI scale? FITYMI stands for Fake It Till You Make It. Does the company really have an actual technology? Or only a demo/proof of concept? Or they are using some kind of proxy as a mechanical turk to imitate technology? The goal is not necessarily fraud detection. There are some legitimate cases for using technology imitation during the initial stages of a startup (as with Concierge MVP). Optimism about the technology is not necessarily fraud, as long as all concerned parties understand the actual state of affairs.
- What are the current capabilities and constraints of the company’s underlying technology? What is the list of features and properties available right now? How many users can the technology currently serve? How fast? How reliably? Is it secure? Is it safe?
- How feasible is the company’s technology development roadmap? Does it support business growth plans? Are the technology development goals achievable within the expected timeline? Are they achievable at all? Is the current R&D team capable of implementing the roadmap? Is the company capable of evolving the R&D team if needed?
E-TDD should be conducted by an R&D expert (or a team of experts), and might take from a few days to a few months, depending on the startup’s stage, industry, complexity and the novelty of its technology, the size of the startup’s R&D team, and other factors.
