Article

Technical Due-diligence

Article published in Mergers & Aquisitions Magazine, May 2003

In the heat of negotiations surrounding investments, acquisitions and mergers, it is all too easy to lose sight of the technology background to the deal.

Investment success in the technology sector requires in-depth understanding of the underlying technologies and a sound analysis of markets and competitive position.

As a product development consultancy also active in the field of technical due-diligence, Plextek Ltd can offer useful insight into this field.

A classic example is the young, technology-led, company with grand plans for moving into volume production. Armed with some patents and a shakey prototype it embarks on setting up production facilities involving high expenditure, aggressive recruitment and training programmes, and invariably a new management style alien to its R&D roots. The investors are also often galvanised by the prospect of high margins on in-house manufacture. And so it is that the party gets underway.

But then the development programme extends, the factory takes far longer to set up, the product proves harder to make, the market window starts to close or takes longer to open in the first place. Financial exposure then soars and panic sets in - often resulting in risky mid-term changes to strategy.
So much of this can be avoided by technology-focused vetting at key stages: not only at investment points but regularly during the company's progress.

For the investor, uncovering fundamental limitations can lead to a significant reduction in the price. In one case our evaluation resulted in a 60% reduction. But due-diligence need not be solely to the benefit of the investor. We usually find that the target also gains from the impartial review: it can raise important factors for business planning and help refine strategic direction.

Vetting a deal can range from a quick review of documentation to hands-on evaluation of designs, checking key staff credentials through interview, and independent cost analysis and programme planning.
Key issues are the strength of core technology, its relevance to product, the validity of product strategy in the target markets and the level of understanding of those markets.

The implementation plan is then crucial. The designs must be fit for manufacture; there must be realistic timescales, achievable resources, correct skill-sets and a viable capital expenditure programme.
There is invariably a profusion of smoke and mirrors with any investment target and it is important to get a realistic view through these. It's pretty difficult to sustain these covers when technologists are quizzed by technologists. Software products, in particular, are notoriously difficult and risky for investors. Software has that interesting property of always being "nearly finished". Quantifying the design status and quality of code requires experienced software engineers.

But technology evaluation is so often marginalised: the patent portfolio often taken as the only measure of technical prowess. But what is a strong patent? We frequently see IP that will be outdated or irrelevant by the time commercialisation kicks in. And is there commitment to protect and assert IP? I suggest that most over-zealous patent portfolios are really only to the benefit of the patent agent. One must judge IP by its relevance and true originality in the prevailing circumstances.

On a wider front, the "green" factor is increasingly prevalent. Not only must companies be environmentally friendly; so must their products. For example, up-coming legislation on the handling and disposal of toxic materials within electronics products (lead-free assembly, battery disposal, etc.,) will impact from 2005 yet so many firms are ignoring this in their technology base.

Fortunately awareness of this need for technical due-diligence is now increasing. Investors and buyers are becoming more alert to its value and, perhaps more significantly, the stock markets are considering mandating greater emphasis on it. In the UK the FTSE and AIM regulators are considering broadening the requirements for pre-vetting applicants.

Technical due-diligence carried out by a company like Plextek, whose core business is contract development, offers investors high integrity vetting. We can then follow through with on-going evaluation of programmes and technology status and possibly by direct engineering assistance to the company.

Written by Malcolm Crisp