Software due diligence in M&A: Key considerations and risks

Mergers and acquisitions (M&As) can be a great way for companies to expand their offerings and market share. One of the biggest risk areas for M&A in tech deals is software plagued with vulnerabilities or that contains open source license compliance issues. That's why software due diligence is crucial in M&A, as it allows acquiring companies to assess the quality of the target company's software assets, and address—or at least plan for—any risks before finalizing the deal.

This blog post explores the key considerations that acquirers should keep in mind when conducting software due diligence in M&A, including the software risks that need to be evaluated.

Overview of software due diligence

Software due diligence is the process of assessing the quality, security, and value of the target company's software assets, including the open source components. It's a critical step in the M&A process as it helps acquirers understand the risks and opportunities associated with the software assets and plan for integration. The software due diligence process should include a comprehensive review of the software development process and organization, software architecture, security measures, and open source–related intellectual property (IP) considerations.

Prediligence

Acquirers should have a game plan for software due diligence before signing the letter of interest. Processes should be defined, vendors identified, checklists developed, and responsibilities assigned. Once things get rolling, there’s little time to think. Having a generic playbook is good, but it should be flexible enough to incorporate concerns that arise in the higher-level conversations that transpire before the deep dive of due diligence. A good practice too, is to set expectations with the target in advance, to allow it to plan and better ensure cooperation once the process is off to the races.

Process and people considerations

Except in pure asset purchases, understanding a development organization’s processes and tools is an important indicator of how the team will operate in the future. It also should provide some indication to the state of the code. That’s not always the case, but a solid QA process should yield less buggy code. If there are plans to scale the organization, the acquirer needs to consider the scalability of the processes. What got a startup to where it is won’t necessarily work when the dev team no longer fits in one room.

The people involved in the software development process can have a significant impact on the quality and security of the software assets. Acquirers should assess the target company's software development team's capabilities, including its technical skills, experience, and certifications. It's also important to understand the culture of the software development team and how it may impact the integration process.

Quality and security considerations

In addition to assessing development processes, acquirers should conduct source code reviews to evaluate the software quality and identify potential vulnerabilities. The source code review should include an analysis of the software's complexity, maintainability, and scalability, as well as its adherence to industry best practices and coding standards. It's also critical to assess the software architecture to identify any design flaws or scalability issues that could impact the software's performance. Finally, security testing should be performed to identify potential security risks and ensure that the software meets industry best practices for security.

Licensing considerations

All software today includes open source components; it is common for the majority of code in a modern application to be open source. But if not well managed, open source software can carry significant risks. Acquirers should identify and evaluate all open source components in the target company's software assets and assess any associated licensing risks. Determining whether the target company has an effective open source management program is a good first step, but in the end, knowing what’s in the code and how it’s licensed is essential.

Integration considerations

Looking forward, acquirers should consider the integration of the target company's software assets with its existing systems. This includes evaluating whether the software is compatible with the acquiring company's systems and identifying any integration challenges that may arise. It's also critical to evaluate whether the target company's software assets can be efficiently maintained and supported in the long term.

The importance of software due diligence

Software due diligence is a critical step in the M&A process, as it helps acquirers understand the risks and opportunities associated with the target company's software assets. By following the key considerations outlined here-including the software risks that need to be evaluated—acquirers can conduct a thorough software due diligence process and make an informed decision about whether to move forward with the acquisition. With careful planning and execution, acquirers can ensure that the software assets acquired are high quality.