Published on Forbes Technology Council 12/27/2022
You are ecstatic: You just executed a term sheet with a startup, which, thanks to your large investment, will grow two to three times each year for the foreseeable future (i.e., two years). Now begins the hard work of ensuring that the CTO delivers the technology and features laid out on the product roadmap. Yet, sustaining high growth, defined (arbitrarily here) as growing revenues at more than 100% per year for at least two years, requires a different playbook than a more mundane growth rate. For example, bigger hardware may accommodate the first doubling of traffic, but the second or third will likely require substantially different software and data architectures, which need to be planned long in advance.
While it is not an investor’s job to identify or address these challenges, the return on investment will ultimately depend on how well and how timely the portfolio company manages them. This article provides pointers on what investors should know and look out for during technical due diligence, as well as post-investment.
The Difference Between High Growth And Regular Growth
In general, growing at a high rate raises four types of challenges.
• Tough Technical Challenges
Handling twice the traffic, with twice the amount of data stored, leads to a different category of problems, technically, compared to handling 10% more traffic. In addition, when you decide to build a new architecture because your traffic is doubling every year, you actually need to design for 10 times the traffic so that you do not go through the same exercise again each year.
• Incremental Changes No Longer Effective
Changes need to be performed in discrete steps. As illustrated above, as traffic surges, incremental measures (e.g., bigger hardware) will keep the business going for a while, but a new architecture needs to be analyzed, designed, implemented and deployed rapidly. Because this work is complex, it needs to start early—well before the real pain starts. Furthermore, the transition to the new architecture often presents a more complex challenge than the new architecture itself.
• The Need For Everything To Change At Once
Along with technical changes in the architecture and the tech stack comes the need to deliver more features faster. This, in turn, requires more engineers as well as a new team organization, along with new tools and new processes.
• Changing Nonfunctional Requirements (NFR)
As the company grows and acquires bigger customers, securing data, meeting regulatory compliance, protecting privacy, preventing downtime and ensuring business continuity take heightened importance. While security might not appear critical for a company managing $10 million worth of transactions, it becomes critical when $100 million flows through the platform. Growing companies often miss this because a slow evolution over time eventually adds up to a category-changing situation.
Where Technical Due Diligence Should Focus
The first step when reviewing a company prior to investment is to identify and quantify impediments to growth. For example, is the amount of technical debt such that even a minor increase in traffic or features will create serious risks of downtime? Do the CTO and the technical leadership have the talent and experience for the design and implementation of the next-generation architecture? Does the CTO have the business acumen, in addition to the technical expertise, to align technical operations with the evolving business?
Next, the plans for growth need to be examined. Are they aggressive enough in scope as well as technology to meet the anticipated growth? How well developed are the plans: Are they conceptual, or do detailed designs exist along with development plans? How robust is the new architecture design? Without detailed plans, the product roadmap is aspirational rather than achievable.
In our investigations, we often see parallel roadmaps for the product, technology and NFR, each assuming access to the same resources. This is a recipe for disaster; fuzzy resource plans lead to fuzzy budgets, misalignment with the CEO and confusion about the allocation of the newly invested funds. The worst case scenario is to find out six months after a deal has closed that the engineering budget needs a 25% increase to deliver the product roadmap because the resources to upgrade the architecture, scalability or security were double counted.
Recruiting and new employee onboarding are often overlooked activities, but when they’re performed poorly, they are a huge, yet hidden, drain on productivity. Because high growth often entails increasing the size of the team quickly, engineers must spend time interviewing prospects. When the recruiting process is poor, candidates do not meet standards, and desirable prospects accept offers from other companies.
As a consequence, engineers end up spending a lot more time in interviews, and building the team takes longer than it should, thus delaying the product roadmap. In addition, frustration builds because time spent in interviews is rarely factored in project scoping, causing delays in projects. Investing time upfront in building efficient recruiting and onboarding processes will be recovered many times over.
Companies rarely have everything figured out. The purpose of the review is not to give a “beauty contest” score but rather to determine whether critical changes need to take place before the company is ready to fully “step on the accelerator,” as well as how much these changes will cost and how long they will take. Getting technical debt to an acceptable level, hiring a new CTO, building a baseline of automated regression tests—all these projects can easily take one or two quarters and commensurately affect the growth rate and revenue.
High growth differs materially from traditional growth by the breadth and speed of the changes that are needed, thus requiring a different playbook. Investors need to know whether a company is ready from day one, whether it will require time to pay down technical debt and whether its growth plans are ready for execution. A lack of readiness can easily consume two quarters, which is a long time in the startup world. It may determine whether the company will dominate its market or get edged out by a faster competitor.