The Ultimate Private Equity Checklist: Software Due Diligence & Development

To capitalize on software company investments, private equity firms must execute a strategic, aggressive approach to the M&A process. This demands mastery over two critical components:

1. Due Diligence – Ensure your firm invests in the best software opportunities and avoids unnecessary risk.

2. Software Development – Increase the value of your software portfolio companies with the right development approach.

This checklist is your blueprint for navigating these stages to generate maximum value and secure high-impact returns.

#1. Ultimate Due Diligence Checklist For Private Equity

Technical due diligence is critical for private equity firms when a software acquisition is on the table. Every software asset carries inherent risks, and without a rigorous diligence process, you risk facing damaging realities post-acquisition:

• The technology fails to perform as advertised.
• The platform is not scalable, preventing future growth.
• The seller doesn’t own crucial components of the intellectual property.

Technical due diligence ensures that private equity firms fully understand the state of the software, its liabilities, and opportunities, enabling them to make better investment decisions.

With this checklist, firms can improve their negotiation position by thoroughly evaluating software (or by vetting the value of a consulting partner).

Technical due diligence is the single biggest differentiator of deals done well—or poorly.

– McKinsey, The Telltale Signs of Successful Digital M&A

Critical Evaluations for Due Diligence

• Performance
• Scalability
• Code quality
• Technical debt
• Integration strategy
• Security strengths and vulnerabilities
• APIs
• Architecture

Critical Deliverables for Due Diligence

• Line-by-line code scan
• Source code analysis
• Stakeholder interviews
• Artifact analysis
• Security analysis
• Team structure analysis
• Executive summary
• Investment risks
• Investment opportunities
• Recommendations

Critical Questions of Due Diligence

Is the software product’s back-end built well?

• Is the code optimized and efficient?
• Is the software architecture scalable and future-proof?
• Are there critical defects in the code?
• Does the software product leverage modern technologies and coding languages?
• What is the full scope of technical debt?
• Is the software built on legacy systems?
• Does the software system follow standard security protocols?
• How is data stored, managed, and governed?

Is the software product front-end built well?

• Is the UX/UI intuitive?
• What are the common friction points in the user experience?
• What are the daily/monthly average users, and is the number growing?
• What kind of customer feedback does the company receive?
• Who is the target user?

Is the software development team well organized?

• Does leadership have a clear vision for the software product roadmap?
• Does leadership clearly understand the current state of their software?
• Does the team have the right roles and skills in place for the roadmap?
• Are the team’s resources utilized effectively?
• What is the team’s development velocity?
• Does the team have sufficient knowledge-share of the architecture?
• What is developer retention and longevity?
• Does the team have standard security protocols in place?

Does the software company have mature processes in place?

• How reliable is the delivery schedule of the product road map?
• Does the development team leverage automation for manual tasks?
• How is software testing and quality assurance managed?
• How common are bug fixes after delivery?
• Do technology projects stay within budget?
• How is the scope of product releases determined?
• Are there clear lines of communication between technology and business teams?
• Is there a plan to maintain the team’s velocity while scaling?
• Does the software company have defined feedback channels?
• Does the software company embrace continuous development?
• Does the company have data governance policies in place?
• Does the company have regular security training?

Is the software company well-positioned in the market?

• Does the company have uniquely differentiated IP?
• Does the company have clear differentiators from competitors?
• Does the company achieve the Rule of 40?
• Does the company leverage generative AI and emerging technologies?
• Where does the company fall in terms of its growth stage?

Is the software company prepared for a potential acquisition?

• Is the leadership team able to answer questions with confidence?
• Does the team have a clear grasp of the software’s problems and a plan to solve them?
• Can the team clearly articulate the value proposition?
• Is the team realistic about the product roadmap and the resources required?
• Is the team collaborative and easy to work with?
• Is the team reliable, transparent, and communicative?

#2. Ultimate Checklist for Private Equity: Value Creation with Software Development

To maximize the value of your portfolio companies, you must invest strategically in the areas that drive tangible results. For software companies, this starts with the core product.

This is especially true in the age of generative AI. The bar for efficient code production is rising, while the barrier to market entry is falling. Your portco’s software – including its capabilities, longevity, and architecture – is the foundation for all other value-creation activities. A powerful product fuels sales, marketing, and ultimately, a successful exit.

This checklist provides a framework for operating managers to take decisive action, hit critical milestones, and engineer more profitable outcomes.

• Assess Software Product’s Current State
• Determine Value Creation Objectives
• Align Product Roadmap with Exit Strategy
• Develop Product Roadmap
• Set Up Development Team for Success

Assess Software Product’s Current State

• Perform technical assessment and due diligence with an objective third party.
• Perform a line-by-line code scan of the software.
• Evaluate the software development team and its leadership.

Determine growth stage & evaluate the portfolio company against the Rule of 40 goal:

• Exploring and building
• Hypergrowth
• Scaling and bridging
• Sustained growth

Identify baseline for key metrics

• Profit Margins
• Customer Churn Rate
• Net Promoter Score (NPS) Score
• Customer Acquisition Cost
• Customer Lifetime Value
• Average Revenue Per User
• Daily or Monthly Active Users
• Product Development Velocity
• Gross and Operating Margins
• Burn Rate and Runway
• Conversion Rates
• ROI for key initiatives
• Determine customer concentration.
• Determine competitive positioning and key differentiators.
• Identify technical debt.
• Review customer feedback and pain points.

Determine Value Creation Objectives

• Evaluate opportunities to improve key metrics.

• Determine priorities of revenue growth vs optimization.
• Perform competitor analysis.
• Analyze the market for new opportunities and trends.
• Identify potential areas for product expansion.
• Align the software company’s vision with the PE firm’s investment objectives.
• Leverage historical performance data to establish new goals.

There’s an ideal time—a Goldilocks zone, so to speak— in every software firm’s journey during which the organization needs to shift its operational mindset from growth at all costs to optimize and improve if it wants to drive long-term value creation.

– Boston Consulting Group, The Real Rules of Growth and Profits in Software

Align Product Roadmap with Exit Strategy

Every item on the product roadmap must align with a specific metric it aims to improve.

Revenue Growth

• Establish continuous software development practices.

• Identify new features and functionalities based on potential product expansion.
• Identify new features and functionalities base on market opportunities for new customers.
• Prioritize new lines of business.
• Foster a culture of innovation
• Create R&D team
• Reward idea generation
• Incentivize internal training
• Establish process for innovation vetting and prototyping
• Evaluate leading technologies, like AI, as revenue-generating and cost-saving opportunities.
• Balance revenue growth against cost savings with the Rule of 40.

Given the challenge of maintaining growth over time, developing the capability to build new lines of business quickly is critical for long-term growth and value creation.

– McKinsey, SaaS and the Rule of 40

Profit, Gross, and Operating Margins

• Review the software company’s cost structure.
• Identify opportunities for efficiency and long-term improvements via:
• Software optimization
• Platform modernization
• Automation
• Generative AI
• Create a plan to resolve technical debt with a backlog of outdated or inefficient code.
• Leverage monitoring tools to track system performance and identify areas for optimization.
• Explore cost-effective development options, such as outsourcing.
• Set dynamic pricing strategies that reflect the value delivered by the software.
• Leverage continuous development and delivery methods to minimize costly bug fixes.

Customer Churn Rate

• Establish avenues for customer and end-user feedback
• Facilitate feedback sessions with key customers and stakeholders.
• Incorporate pain points into the product development roadmap.
• Evaluate and prioritize user experience enhancements.
• Monitor NPS score regularly.

Customer Acquisition Cost, Customer Lifetime Value, and Average Revenue Per User

• Balance CAC against potential CLV, and group customers accordingly for marketing and sales efforts
• Identify profile for high-value customers.
• Identify features that attract and retain high-value customers.
• Evaluate opportunities for premium features.
• Evaluate opportunities for up-sells and cross-sells.

Good Pricing + Strong Product Support + Postsale Constructs + Talent Retention + Analytics

= 120%+ median net retention rates (NRR)

=20% growth every year without adding a single new customer

– McKinsey, SaaS and the Rule of 40

Daily or Monthly Active Users

• Evaluate features that enhance user engagement.
• Evaluate features that improve product stickiness.
• Evaluate customer and end-user behavior to identify friction points.

Product Development Velocity

• Support the adoption of agile development methodologies.
• Encourage DevOps practices to streamline development and deployment processes.
• Consider continuous development with global talent across time zones.
• Expand development team capacity as needed.
• Invest in tools and training to streamline product development:
• Generative AI – ChatGPT, CoPilot, etc.
• Automate repetitive manual processes, such as software testing
• Minimum Viable Product (MVP) development approach
• Evaluate and improve time-to-market.
• Evaluate and improve delivery cycles.
• Establish clear product roadmap priorities and reduce bloat and scope creep.

Top-quartile companies are increasingly exploring the use of artificial intelligence (AI) and machine learning in developer tools.

– McKinsey, How Software Developers Can Drive Business Growth

Burn Rate and Runway

• Optimize resource utilization.
• Manage computing resources efficiently, such as:
• Investing in cloud-based infrastructure
• Investing in scalable solutions
• Scale with demand to accommodate increased user activity without significant infrastructure costs.
• Invest in robust security measures and regular testing to avoid large financial losses due to cyber attacks.
• Factor in maintenance costs for the development of new features.

Conversion Rates

• Leverage marketing and sales tech stacks to determine conversion rates at different stages of the sales cycle.
• Track prospect activity with tools like Salesforce.
• Determine and answer common objections.
• Perform closed-lost analysis.
• Evaluate sales and marketing collateral.
• Align software capabilities with go-to-market messaging.
• Plan go-to-market strategy in lockstep with the product roadmap.
• Evaluate opportunities for free trials and demos with lean versions of the product.

ROI for key initiatives

• Establish KPIs for each initiative.
• Evaluate ROI for each initiative.
• Iterate on approach and execution based on analysis.

Develop Product Roadmap

A strong product is instrumental in driving solid metrics across revenue growth, gross margin, and retention.

– Brad Weekes, Managing Director at SEG

Prioritize product development initiatives based on:

• Potential impact to key metrics
• Certainty of success
• Cost
• Time investment
• Risk
• Resource allocation

Delineate necessary vs. nice-to-have updates

• Necessary: solving technical debt
• Nice-to-have: new features

Divide the product roadmap into distinct phases based on:

• Strategic priorities
• Dependencies
• Clearly define the expected outcomes and performance indicators for each initiative.
• Allocate budget and resources to each initiative.
• Establish clear milestones for each phase, allowing for iterative development.
• Establish a cadence of evaluations for development progress.
• Develop mitigation strategies for risks.
• Establish a regular cadence of communication between the software company and the PE firm.
• Establish deadlines and touch points for updates.
• Plan for user testing and validation of new product features and updates.
• Gather feedback from targeted user groups to refine and improve product roadmap items.
• Iterate on the product roadmap based on feedback and ROI.
• Continuously align product roadmap with the exit strategy.

Set Up Development Team for Success

Based on the product roadmap, identify skill and capacity gaps in your team.

Set up a budget and timeframe to fill the gaps

• If hiring internally, plan for buffers to accommodate talent shortages.
• If outsourcing, plan to evaluate partners for quality, transparency, and efficiency.
• Ensure leadership is aligned with the exit strategy and product roadmap.
• Define technical team leads.
• Define points of contact between technical and business functions.
• Establish clear feedback channels.
• Establish a consistent cadence for updates.
• Evaluate and enhance talent retention strategies.

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