Investing in tech? Want a few simple avenues to understand how tech performance affects valuation? CTO Labs are go to advisors in M&A tech with a strong focus on asset performance. We're technologists who've lived in the trenches in the start-up, scale-up, and the already set-up space. We partnered with Letter of Intent to unpack a few tech deal themes for readers.
Let’s look at a simple little analogy, think My Kitchen Rules… (don’t forget the sauce ;)
Imagine you’re hosting friends for a special dinner. You’ve got a great night planned, lots of courses, the kitchen is looking organised and together. You’re midway through prepping the entree when your friends arrive early. No problems, a quick pivot and you bring the entree timing forward. Entree served…but this has introduced a little bit of complexity. Your main course is now due earlier, plus you didn’t have time to clean the pots ready to cook mains (a little bit more complexity). You manage to collect the plates, wash them, get them ready for mains but a little bit of creative stress is starting show and you forgot to make the sauce.. (a little bit more complexity) Oops that sauce takes 20 minutes… and now you have a quality problem, succulent mains are ready, getting cold without the sauce…and you now have a speed problem.
And at scale…
Imagine this same scenario in a commercial kitchen, there are teams of people looking after each of the kitchen areas (from food prep to serving) and these teams need to be in sync in order to deliver quality meals on time to guests. In a commercial kitchen the customers vote with their feet.. Oh and as a compound affect, they will likely leave a review (2.4 stars if they are generous).
And.. back into Tech…
Let's keep that process in mind and jump back into tech… You are a developer working on a new feature. It is complex and time is tight, so you decide to introduce a little ‘short-cut’ to get the feature out quicker, this short-cut means you have to go-back later and fix it (make it secure, scalable, check quality - you get the idea). IE: technical debt. Now this is all normal, and if it’s handled consciously, and planned for prudently, it’s manageable. But if it’s not “red flag… red flag”...
A recent McKinsey article put Tech Debt as up to 40% of tech spend.1
And at scale again…
Almost done… A modern tech team will release multiple features per week and features are not linear, IE: They depend on other features that were created previously…So if you didn’t fix that last feature and you now need to build on top of it….well, I guess you can see a little challenge forming?
WTF: Why should I care?
Simply put… technical debt incurred over time has the potential to erode value through reducing velocity, and lead to a large capital requirement to resolve. For a refresher on Velocity and how it affects valuation read last month’s Tech Tips here.
The impact areas are mostly likely to be in: (although they will differ per asset)
Balance sheet impact: Potential compounding problem with eroding value and high investment required to remediate
Low quality: A reduction in overall quality leading to bugs, issues, platform stability and resiliency problems
Unreliable estimates: A lack of clarity into the health of the platform leading to an inability to effectively estimate time and budget to deliver new features
Reduced speed to market: An inability to address market opportunities in a nimble manner
Lack of trust: A CEO who is left scratching his head, wondering what happened to a once high performing tech team
Rebuild requirement: It is often cheaper to rebuild parts of a platform than to solve the problems (remember an iconic Australian online food delivery brand transaction… this as their achilles heel)
Poor team morale: A general frustration within the team at their inability to perform…often leading to attrition
So… What do mature tech teams do?
High performance teams take on debt in a conscious and structured way. Taking on debt is always partnered with a plan to pay it back, and to do that quickly.
There are multiple options to do this but a common approach is a tech debt tax, carving off a portion of your delivery capacity to pay down some of your debt. Always be paying back and chipping away at that debt pile. This way you can prioritise what to pay back first so that it hurts you the least. If teams don’t have a plan to pay back debt then … (oops, see chart above).
Can I have the good stuff please?
So here’s the bit to bookmark.
Every tech team has “technical debt”
Technical debt can be managed and estimated and included in R&D spend estimates
High performing tech teams make a conscious decision when taking on debt and pay it back based on commercial priorities
Low performing teams are often unaware of their technical debt (and we have seen quite a few) and their owners wonder why their tech is not performing
……And over time is likely to impact your valuation and potential return.
A key thing you’re going to want to ask early on is what’s their tech debt payback plan - and depending on the answer you get, you may want to explore things further.
Considering a Tech Asset?
We’ve got a list of ten key questions you can ask any tech target: Book a callback below, or send us an email and we’ll gladly send you yours.