Due Diligence must grow up: Maturity Modeling is the way to uncover risks, discover opportunities


Kickdrum Technology Group, Tom Carter, private equity, venture capital

By Tom Carter, Kickdrum Technology Group

Due diligence is fundamental to the success of every deal, whether an investment or acquisition. You know what the company has told you and what your investment thesis says, and now it’s time to send in the consultants, lawyers and accountants to dig deep and uncover the truth. This vetting process is critical to hitting it big and avoiding catastrophe.

But the numbers suggest many are doing it all wrong.

For all the talented MBAs and the intensive financial modeling, many deals fail. Even those that succeed often fall short of forecasts. But what if this doesn’t have to happen? What if the common PE bogeymen — changing market conditions, new competitors or other unforeseen external challenges — aren’t to blame? What if, instead, it’s the simple fact that traditional due diligence is broken?

I argue that due diligence on companies is indeed broken, in three key ways:

Due Diligence Is Binary: While the due-diligence form may be filled with yes/no checkboxes, anyone who has been through a PE deal knows that little is black and white but instead the world is a series of greys.

Due Diligence Is a Snapshot: Due diligence of a business will no doubt uncover important issues that inform investor decisions, but that information is too often a static snapshot that offers little visibility into the potential for improvement.

Due Diligence Offers No Path Forward: Even if it is accurate in its depiction of a company’s standing, the disconnect between pre-deal analysis and post-investment execution introduces many avoidable risks.

Due diligence must go further than the “yes they do / no they don’t” paradigm. It should answer questions in degrees and, equally important, offer a road map to improvement. We call this approach Maturity Modeling.

While we have our own maturity model at Kickdrum, any PE or buyout firm can use this approach to create a model that fits its own needs. In fact, it’s particularly helpful for smaller firms without the staff or resources of the PE giants.

Maturity Modeling fundamentally improves the way firms evaluate the foundation on which a company is built. For each element of a company’s business — market fit, HR, development, R&D, operations, etc. — Maturity Modeling establishes a series of levels, each with specific and well-defined characteristics and required actions to get to the next level.

The basic structure of a Maturity Model is:

Level 1 (poor)
Level 2
Level 3
Level 4
Level 5 (excellent)
Evaluated Area
No competence / significantly lacking
Just the basics
Starting to see value, positive effects on cost/timing
Measurable, repeatable impact to speed and bottom line
This is accelerating growth

The beauty of this approach is that it produces two outcomes: a truly accurate assessment of how things are and a road map for where they need to go post-investment.

From an assessment perspective, a company that falls into any of the first three areas will almost certainly struggle with growth, facing significant risks that could injure the business and cause it to fall well short of projections. Those in levels four and five, however, are well positioned to be growth drivers. From a road-map perspective, this process shows exactly what that company needs to do to move up the Maturity Model, unleashing value on the way.

For an example of Maturity Modeling in action, traditional due diligence may look at a prospective investment’s client base to gauge customer strength, whereas our proposed approach would look at the sophistication of the client-servicing team’s processes. And where due diligence might measure the quality of proprietary software, Maturity Modeling digs into the processes required to maintain that quality.

Level 1 (poor)
Level 2
Level 3
Level 4
Level 5 (excellent)
Customer Involvement
Product team has no access to customer use information (CUI). Reactive response to customer issues
Access to CUI exists. Customers engaged in road map. Automatic delivery of updates/installs
CUI is available to product team and used by others (some proactive action). Features result from CUI.
>= 50% of features/ road map from CUI. Road-map process centered on CUI.
Customer testimonials dot product marketing. Customers compete (i.e. pay) for inclusion in PMM.

 

Level 1 (poor)
Level 2
Level 3
Level 4
Level 5 (excellent)
Quality Assurance (QA)
None or all manual w/no understanding of coverage
One-click run all tests locally;
0%-20% coverage
Tests run against shared integration environment; unit, component and integrations tests. 20%-40% coverage.
Tests run on nightly build against integration environment; Automated performance tests. 40%-60% coverage.
Every commit tested; security scans; business value verification. 60%-80+% coverage.

We believe five levels is the right number for each evaluated process — for both assessments and tracking — but Maturity Modeling is infinitely adaptable to reflect the specific needs or investment experience of each PE firm. A Maturity Model, whatever the number of stages, enables a PE firm to determine not just how well a company is doing but also to know how much effort (and cost) it will take to improve it and how much value can be unlocked.

For too long, traditional due diligence has fallen short of PE investors’ needs. Maturity Modeling takes the same important questions that have always been asked — but it goes far beyond a simple vetting of a company’s claims or position in the market, uncovering hidden value, spotting unknown risks and identifying areas to enhance ROI.

Tom Carter is a co-founder of and principal at Kickdrum Technology Group, a customer-software-development firm, and was a co-founder of Trilogy Software.

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