Technology Due Diligence: The Need for and Benefits of Technology Assessment in Connection with Investment in High-Tech Companies

By Goforth, Carol R.; Goforth, Ronald R. | Rutgers Computer & Technology Law Journal, Summer 2001 | Go to article overview

Technology Due Diligence: The Need for and Benefits of Technology Assessment in Connection with Investment in High-Tech Companies


Goforth, Carol R., Goforth, Ronald R., Rutgers Computer & Technology Law Journal


It seems like technology is in the news on a daily basis, particularly the financial news. First, technology investments "skyrocketed," (3) with technology companies serving as the "darlings of the investment community." (4) Then, in mid-April of 2000, the "tech-heavy Nasdaq market plummeted," losing percent of its value. (5)

This volatility in the public markets means a tougher ride ahead for technology companies, and not just those whose stock is already publicly traded. Venture capitalists are backing away from technology deals, with the consequence that some companies are unable to secure adequate funding for their operations. (6) Meanwhile, merger and acquisition activity in the tech-area continues to boom, with billions of dollars at stake. (7)

In these times of market volatility, technology due diligence is a concept of potentially critical importance. Companies desperate for additional sources of financing need a way to convince investors that their projects have real value. Venture capitalists and other potential investors need a way to investigate such claims. Businesses seeking potential merger partners must be able to evaluate the underlying value of the target company. Lawyers and other professionals involved in these deals have disclosure and other obligations which require them to be able to make good faith estimates about the nature of these companies' businesses. (8)

Without the ability to independently demonstrate or investigate the viability of technology projects, investors will not have the information necessary to support sound investment decisions. Technology-based companies may find it impossible to attract needed investment because their products or processes are poorly understood. Professionals retained to provide advice in connection with the financing of these deals may face the risk of lawsuits claiming that they made false and misleading statements about the technology. (9) Finally, the public sector is also likely to make very poor business decisions unless technology claims can be investigated, because of the government's continuing commitment to support the development of new technologies. (10)

This article will describe the concept of technology due diligence in some detail, and will contrast it with the types of due diligence traditionally conducted in connection with investment in new and emerging companies and the acquisition of more developed enterprises. It will also examine how the divergent interests of potential investors and the proponents of new technologies increase the need for technology-based assessment. In connection with this analysis, this article suggests a paradigm shift in which technology due diligence becomes an accepted requirement any time investment in or acquisition of a technology-based company is proposed or considered. The article also considers the ways in which technology due diligence can benefit each of the different interests at stake when considering investment in a technology-based venture. It will conclude with a suggested approach for evaluating technology due diligence proposals, to insure that the due diligence will be appropriately conducted.

I. WHAT IS TECHNOLOGY DUE DILIGENCE?

When presented with an attractive business opportunity that is based on sophisticated new or evolving technology, anyone with less than expert knowledge of that technology will need help to fully appreciate the risks involved with technology and its use in the business venture. Anyone who fails to undertake a due diligence assessment, which includes a competent analysis of the underlying technology, may unsuspectingly invest in a superficially attractive but ultimately impossible enterprise. Similarly, a company that fails to acknowledge and respond to the risks inherent in new and developing technologies may be unable to attract needed investment or may find itself exposed to potential liability for claims made in connection with the issuance of securities. …

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