In our analysis of over 100 M&A transactions, we've found that hidden technical debt accounts for an average of 15-25% of post-acquisition remediation costs. For a $50M deal, that's $7.5M to $12.5M in unexpected expenses that rarely appear in the seller's disclosures.
What Is Technical Debt in M&A Context?
Technical debt represents the accumulated cost of shortcuts, deferred maintenance, and suboptimal decisions made during software development. While the term originated in software engineering, its implications extend far beyond code quality in M&A transactions.
Technical debt manifests in several forms:
- Code-level debt: Poorly structured code, lack of tests, outdated dependencies
- Architectural debt: Monolithic systems that should be microservices, tightly coupled components
- Infrastructure debt: Outdated servers, manual deployment processes, missing disaster recovery
- Documentation debt: Missing or outdated technical documentation, tribal knowledge
- Security debt: Unpatched vulnerabilities, inadequate access controls, compliance gaps
Why Sellers Don't Disclose Technical Debt
It's rarely malicious. Most sellers genuinely don't know the extent of their technical debt. Development teams often normalize workarounds, and unless you've conducted a formal assessment, the true cost remains invisible.
Additionally, technical debt doesn't appear on balance sheets. There's no GAAP requirement to disclose "we've been deferring database upgrades for three years." This information asymmetry creates significant risk for buyers.
The Real Cost: A Case Study
We recently assessed a $35M SaaS acquisition for a PE firm. The target appeared healthy: $6M ARR, 40% growth, 85% gross margins. The technology stack was described as "modern" and "cloud-native."
Our assessment revealed:
- $2.1M in immediate remediation needs: Security vulnerabilities requiring urgent patching, database migrations that couldn't be deferred
- $3.4M in 12-month modernization costs: Rewriting core services to handle projected scale, implementing proper CI/CD pipelines
- $1.8M in ongoing annual costs: Technical team augmentation needed due to key person dependencies
The total: $7.3M in technical debt on a $35M deal—a 21% hidden cost that would have destroyed the investment thesis if not identified pre-close.
How to Identify Technical Debt Before Closing
1. Code Quality Analysis
Automated static analysis can identify code smells, complexity hotspots, and dependency issues. But tools alone aren't enough—you need experienced engineers to interpret results and identify what matters for your specific situation.
2. Architecture Review
Examine how the system is structured. Look for:
- Monolithic applications that should be decomposed
- Circular dependencies between components
- Single points of failure
- Scalability bottlenecks
3. Infrastructure Assessment
Evaluate the deployment and operations environment:
- Are deployments automated or manual?
- What's the disaster recovery capability?
- How are secrets and credentials managed?
- What monitoring and alerting exists?
4. Team Interviews
Talk to the engineers. Ask about pain points, areas they'd improve given time, and what keeps them up at night. Development teams often know exactly where the bodies are buried.
Negotiating Around Technical Debt
Once you've identified and quantified technical debt, you have several options:
- Purchase price reduction: Negotiate a dollar-for-dollar reduction based on remediation costs
- Escrow holdback: Hold funds in escrow tied to specific remediation milestones
- Seller remediation: Require the seller to fix critical issues before closing
- Earnout adjustment: Tie earnout payments to successful remediation
- Walk away: If the debt fundamentally undermines the investment thesis, don't proceed
The Bottom Line
Technical debt is real, quantifiable, and material to M&A transactions. Ignoring it doesn't make it go away—it just means you'll pay for it post-close, often at a premium.
The cost of a thorough technical due diligence assessment is a rounding error compared to the potential exposure. For deals over $10M, there's simply no excuse for not understanding what you're buying.