Improving the M&A process and transaction performance
How corporate M&A teams are leveraging code diligence
Foundations for Corporate M&A Teams
Executing Code Diligence
Software code diligence is becoming standard practice for many corporate acquirers.
The goal is to assess the target’s technology assets to identify risks, liabilities, and post-close opportunities.
In many acquisitions, code diligence quantifies the target's 'technical debt,' allowing buyers to plan for any necessary integration tasks and potentially negotiate to remediate expenses directly from the purchase price.
Code diligence reports typically provide insights into:
- Quality of the codebase and scalability potential
- Use of various licenses and open source code
- Health of the technology infrastructure
- Critical cyber security risks
Open Source and IP Risks
Code reviews look at open-source and third-party components to verify license compliance, preempt IP claims, and ensure a clean title can be transferred post-close.
Deal parties will generally negotiate to allow read-only access to the source code repositories (e.g., GitHub, GitLab, AWS CodeCommit, Google Cloud, etc.) to conduct a Software Composition Analysis that identifies every open-source libraries and their associated licenses.
A key concern is that an acquisition will shine a spotlight on the seller and attract IP claims against the new owner, which is often a more attractive litigation target.
Cyber Security Concerns
Corporate M&A professionals also pointed to the value of code diligence for identifying potential security flaws, cyber-breach vulnerabilities, and general weaknesses in the target's codebase.
To extend the code review, Static Application Security Testing (SAST) analyzes proprietary code for structural quality, security flaws, and hardcoded elements.
In some transactions diligence extends to the target's hardware, network / cloud infrastructure, data storage, recovery, privacy compliance (e.g., GDPR, CCPA), and data governance policies.
Increasingly AI-enhanced code reviews are giving M&A teams greater efficiency and scale, which is particularly helpful in accelerated deal processes.
The move beyond manual code diligence deepens the analysis by instantly flagging syntax errors, style violations, pattern-based security vulnerabilities, and performance bottlenecks.
Code Diligence: Red Flag Reports
A comprehensive code diligence report translates technical debt into a thesis-driven financial assessment, estimating the exact time and costs required for remediation.
This financial analysis can then be used by the M&A team to adjust the purchase price, demand pre-close remediation, or set up escrow holdbacks.
Members of the Institute's speaking faculty have suggested corporate development teams coordinate with the legal and engineering teams to align liability caps, financial thresholds (baskets and deductibles), and materiality qualifiers in the purchase agreement.
They have also recommended a higher level of coordinate with the M&A Integration team to evaluate:
- Integration Friction: Assess tech stack compatibility; identify legacy frameworks, obsolete languages, or incompatible databases needing costly rebuilds.
- Key-Person Dependency: Examine commit history for critical infrastructure reliance on select developers, flagging operational risks if they exit post-close.
- Viral License Exposure: Detect "copyleft" open-source licenses that could legally mandate exposing the acquirer's proprietary source code.
- Scalability Roadblocks: Evaluate if the current architecture supports growth projections or requires significant capital expenditure to prevent failures at scale.
- Third-Party Vendor Reliance: Map external API and vendor dependencies to identify potential supply chain, data privacy, and margin risks.
Engineering Talent Retention
Although most deal teams aim to assess the target’s talent and skill during diligence, a poll at the annual M&A Conference San Francisco found just 10% of the participating deal teams shared code diligence findings with the M&A HR team.
This finding suggests more could be done to leverage code diligence to identify critical talent and tailor the retention strategy.
In fact, some of the most effective M&A teams are using code reviews to put additional retention funds against select developers that produced high-volume and quality code.
These assessments are also helping the M&A integration team determine whether to maintain the target’s software development lifecycle methodologies, development tools, and technologies post-close.
Timelines for Code Diligence
Negotiations with the seller should allow sufficient time to review the target's code, IP portfolio, relevant agreements, and acquisition history.
A high-level review can often be done in 1-2 weeks, while a standard review takes 2-4 weeks.
A more thorough analysis, including performance testing, detailed security assessments, scalability analysis, and a comprehensive IP review may take 4-8 weeks.
Factors influencing the timeline include:
- Quality of documentation, readability, and overall software design
- Availability and responsiveness of the target company's team
- Size and complexity of the codebase and technical architecture
- Scope of the review and expertise of the diligence team
Exclusively for Members of the Transaction Advisors Institute
Advanced Playbooks, Templates, and Negotiation Frameworks
on Leveraging Code Diligence
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FAQ on Code Diligence in M&A
Several deal points can be incorporated into the acquisition agreement including representations and warranties that the seller has clear and unencumbered ownership of all IP rights, including copyright, patents (if any), trade secrets, and that the code does not infringe upon the IP rights of any third party.
It’s also important to ensure the acquisition agreement is clear on representations as to the use of open-source software and warranties that the target company has complied with all applicable open-source licenses to head off restrictions on future use.
Increasingly, corporate M&A teams are obtaining representations and warranties insurance (RWI) to provide coverage for breaches related to IP in the code. This can offer an additional layer of protection that is easier to pursue than a claim upon the seller.
If any issues do arise, the buyer will want to have insisted upon comprehensive indemnification clauses to protect against any losses, damages, liabilities, costs, and expenses arising from any breach of the IP-related representations and warranties.
In parallel with third-party code diligence, the Institute's member have suggested using internal engineering teams to evaluate the target’s code for scalability and proper protocols.
To best assess post-close integration challenges and opportunities, it can be helpful to apply internal ratings to evaluate the target’s engineering team against the company’s specific standards (i.e., ask, ‘How would we measure them if they built code here?’.’).
To execute an effective peer-to-peer review, it has also been suggested that corporate development should stay out of the room, and only interface with the product teams, rather than directly with engineering.
The Institute’s members have found that ‘engineer-to-engineer’ discussions tend to reveal far more meaningful insights.
Having corporate development in the room may stifle the exchange and shift the focus to the economic and legal aspects of the transaction.