The hidden business risks of technical debt in mergers and acquisitions

The components of technical debt

Before delving into the importance of identifying technical debt in due diligence, let's briefly define it further. Technical debt refers to the cumulative hidden costs of suboptimal decisions made during the SDLC. These decisions often prioritize short-term gains or expediency over long-term quality and maintainability, and they may never be revisited. The result can be an invisible burden on a company’s future development. Technical debt can manifest in a variety of forms, such as

• Code quality: Poorly written and undocumented code can be a major liability. It can lead to maintenance challenges, longer development cycles, and increased risk of defects.
• Architectural and design health: Inadequate system architecture and design can hinder scalability, performance, and adaptability, limiting the potential for future growth.
• Open source license compliance: Failure to adhere to open source licenses can result in legal complications and lawsuits, which can be costly and reputation-damaging if not cleaned up.
• Security vulnerabilities: Proprietary code riddled with security flaws can be exploited, leading to data breaches, financial losses, and loss of customer trust. Using unpatched, vulnerable open source components exposes a company to these same threats.
• SDLC process methodologies: Inefficient, immature, or incomplete SDLC processes can result in project delays, budget overruns, and frustrated stakeholders.

The due diligence phase and its significance

During the due diligence phase of an M&A deal, an acquirer should meticulously assess the financial, legal, operational, and technical aspects of the target company. The goal is to identify potential risks, uncover hidden liabilities, and ascertain the true value of the target company. This phase is crucial for making informed decisions, planning integration, and avoiding future issues that might otherwise arise post-close. It is crucial to uncover technical debt in the due diligence process because it can impact subsequent business operations.

• Cost implications: Technical debt can be costly. Uncovering code and design quality issues, security vulnerabilities, or open source compliance problems late in the acquisition process can illuminate significant future expenses. Remediation, re-engineering, and legal settlements can quickly erode the expected benefits of the merger or acquisition.
• Time delays: Dealing with technical debt issues can lead to delays in integration and product development. Time is often of the essence in M&A deals, and any holdups can have a ripple effect on project timelines. And any inability to swiftly respond to market changes can erode the value of the acquisition.
• Reputational damage: Failure to identify and address latent issues can tarnish the reputation of the acquiring company. Data breaches or product failures due to security vulnerabilities can lead to loss of customer trust and market credibility.
• Legal risks: Unresolved open source license violations or legal disputes related to code ownership can expose the acquiring company to lawsuits and regulatory fines.

The way forward

To mitigate the business risks associated with technical debt, both acquiring and target companies should take proactive steps.

• Preacquisition assessment: Conduct thorough software due diligence early in the M&A process to identify and quantify technical debt issues. This includes evaluating code quality, architecture, security, legal vulnerabilities, and design and development processes. This requires an in-depth analysis of the target’s codebase.
• Clear remediation plans: Develop clear plans to address technical debt post-acquisition, including timelines and budgets for remediation efforts. This helps in negotiating the deal terms and estimating the true value of the target company.
• Collaborative integration: Encourage collaboration between technical and business teams to ensure a smooth integration process and plans that align with the strategic objectives of the acquisition.
• Continuous monitoring: Prioritize and implement ongoing monitoring of code and design quality, security, and legal compliance to head off future accumulation of new technical debt.

Conclusion

Technical debt is a hidden risk that can jeopardize the success of an M&A deal. Companies should recognize the importance of addressing technical debt during due diligence to avoid costly surprises and ensure a smoother integration process. By doing so, they can protect their investments and enhance the chances of a successful merger or acquisition.

In an increasingly digital world, technical debt is an ever-present threat to any organization. By taking proactive steps to understand and manage it, businesses can navigate the complex landscape of M&As more effectively, ultimately achieving their growth and strategic objectives.