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By Scott B. Meyer, Glenview James LLC

Due diligence today needs to begin with the assumption that every deal is a tech deal. So what do you do when you discover that a prospective investment hasn’t fully embraced digital transformation?

In this installment of my four-part series, “Making Money When Every Deal is a Tech Deal,” we’ve examined “Tech Buzzwords” and “Claims of Immunity.”

Now let’s look at the “Digital Transformation Conundrum”: why it’s hard to get digital right from an operational perspective.

This dynamic is particularly challenging when a company isn’t a tech company at its core. Management isn’t as familiar with the upsides, and risks, of a robust digital strategy to drive private equity returns.

With sales, marketing and finance, there are longstanding, proven metrics to diligence the quality of the strategy and the execution. Measuring success for technology investments is harder. This is the Digital Transformation Conundrum. It’s hard to set priorities for digital investments.

I’ve noticed four types of efforts in this area:

1. Necessary infrastructure investments.
2. Applications that are doable with the current tech stack.
3. Applications that require new software and/or people.
4. Terrible ideas pushed by the management team, clients or the board

Necessary infrastructure investments are pretty obvious. They need to happen to keep the current trains running on time. These projects are also favorites of the IT team. They typically lock in the current architecture. That means job security.

Infrastructure improvements, however, can hardly be the entire digital strategy. Companies need new applications all the time. This can be anything from a new email marketing system to integrating a data warehouse with your CRM. Projects like this are easy as long as they are well-integrated with the current tech stack. Safe, yes. Breakthrough? Usually not.

Breakthroughs can come with applications that require new software and or people. There are three ways these investments can turn out: a) a smart investment that is executed well; b) a smart investment that is executed poorly and c) a weak idea that, even if executed well, actually hurts the company.

Situations b) and c) can lead to “Technical Debt.” Think of technical debt as the cost of taking shortcuts. IT teams with a weak digital strategy accumulate a lot of technical debt. They push out individual projects based only on speed and low cost. The company should always be on guard against weak ideas — especially those pushed by the CEO, the board or a subset of clients.

It’s also important to keep in mind that all of this is a potential minefield for a company’s engineers. They’re facing a huge to -do list. Some projects are risky, time consuming and expensive. They don’t want to get blamed if things don’t work out.

In diligence, if the sponsor can’t effectively screen against this conundrum, either pass or be prepared to replace the CIO, and potentially the CEO, quickly.

Some funds have a SWAT team that comes in post-close to get the tech team into shape. If your fund doesn’t have that, then it’s a good idea to have a reliable team of consultants with you in diligence and ready to clean things up post-close.

Next up in Part IV: The Risk of Process Over Results

Scott B. Meyer is owner and principal consultant at Glenview James LLC. His practice centers on digital due diligence and digital transformation work for sponsors and portfolio companies. Reach him at scott@glenviewjames.com and at @scottmeyer.