Private equity challenges: The impact of technical debt in tech investments
In this article
Summary
Technical debt is a hidden killer in the world of software private equity and tech investments.
In the rush to launch products, developers often make compromises. This results in messy, inefficient, and even vulnerable (security and open source) code also known as “technical debt.” If investors do not thoroughly check the details, they may unknowingly take on these costly inefficiencies and inherit all the risks that come with it.
Just like financial debt, technical compounds. This hidden problem inflates acquisition costs, increases operational expenses, and delays ROI—ultimately jeopardizing investment theses and portfolio performance.
Beyond financial losses, technical debt can stifle scalability, delay growth, and even lead to cybersecurity breaches or costly regulatory non-compliance—posing risks that PE firms can’t afford to ignore.
In this article, I aim to define the definition of technical debt through the lens of PE tech investments, and by giving a few real-world examples of how it affected businesses. After that, I will provide an overview of the short- and long-term cost of failing to gauge technical debt or remediation efforts.
At the end of the article, I will go into more depth about the 5 best practices for addressing technical debt in private equity due diligence:
- Treat technical debt as a business issue, not a tech issue
- Conduct source code analysis to signal tech debt and pay-off tech debt in an early stage.
- Evaluate the scalability and future-proofing of existing systems
- Prioritize critical debt remediation pre-close
- Embrace technical debt management
Introduction
Private equity investors are generally well-versed in identifying troubled assets with the lowest downside risk and most promising upside potential. Yet, when it comes to tech investments and software acquisitions, technical debt—a silent threat to valuations and ROI—is often overlooked.
Technical debt, sometimes called tech debt, or ‘the tax,’ is hard to quantify and tends to be hidden from, if not entirely invisible to, investors. New York Times author Christopher Mims recently called it the hidden$ 1.52 trillion problem.
It inflates acquisition costs and undermines scalability and integration efforts. Left unchecked, it can derail value-creation strategies and lead to investment failures.
Recent data from CIOs interviewed by McKinsey suggests that up to 40% of an organization’s entire technology estate is consumed by technical debt. At the M&A level, our analysis shows that 31% of acquired codebases are riddled with technical debt—posing a significant threat to valuations and growth strategies.
If unassessed pre-acquisition, technical debt can emerge as a nasty surprise after the deal is done—devaluing your asset, demanding costly remediation, stunting growth, and prolonging your firm’s journey to realizing ROI.
Thankfully, technical debt doesn’t have to stay hidden. Early assessment of technical debt during due diligence not only mitigates risks but can transform it into a strategic advantage—protecting valuations and maximizing returns.
This article is your roadmap to understanding technical debt—what it is, how it impacts valuation, and, most importantly, how software private equity investors and fund managers can tackle it head-on. Discover actionable insights on how to mitigate risks and even transform technical debt into a strategic advantage.
Technical debt defined
To address this invisible threat, it’s crucial to first define what technical debt is and understand how it accumulates.
Look up tech debt and you’ll find lots of different—sometimes conflicting—definitions. In the world of software quality and development, we use the term ‘technical debt’ to define the various costs which arise over time from building poor quality, inefficient software.
How does technical debt compound?
In their rush to launch products, developers often make compromises that result in disorganized and inefficient code, a phenomenon known as “technical debt.” If investors do not scrutinize the details, they may unknowingly take on these costly inefficiencies. This can increase operational expenses and delay the returns on their investment.
While no software is entirely free of technical debt, understanding its scope and impact is critical for private equity investors, as it directly affects valuation, post-close growth strategies, and ROI.
Worryingly, independent Software Improvement Group research discovered that Mergers & Acquisitions in software private equity trends toward poorer quality software products. In fact, of 531 M&As assessed, the quality of the software was below average and the amount of technical debt in the software was over a third.
Real-world examples of how technical debt can hurt business
Let’s explore how technical debt has derailed businesses and eroded valuations in high-profile cases.
Friendster: Missing the scalability mark
Technical debt can spell the difference between market dominance and failure. For instance, in the early 2000s, Friendster had a first-mover advantage over rivals like MySpace during the early social media boom.
As key Friendster investor (and later PayPal investor) Reid Hoffman explains, “It was Friendster’s game to lose.” Yet, Friendster’s code was inefficient and couldn’t scale with rising user demand. Page-load speeds lagged behind MySpace’s, which had better-designed, scalable code.
The result? Friendster lost its lead, faded into obscurity, and saw its valuation plummet.
Nokia and the smartphone era
When technical debt goes unaddressed, even the strongest brands can falter. Nokia, once a leader in mobile phone manufacturing, failed to adapt to the smartphone era.
Why?
Because the technical debt they’d silently been accruing for years meant that their existing operating system (OS) wasn’t up to the task of scaling and adapting to the emerging smartphone era. Nokia missed out, and in 2013, was forced to sell to Microsoft.
When Microsoft acquired Nokia in 2013, the hidden technical debt hindered integration efforts, resulting in a $7.6 billion write-off and nearly 8,000 layoffs. The inability to manage technical debt turned a once-lucrative investment into a significant loss.
Southwest Airlines: Stranded by outdated systems
During the 2022 holiday season, Southwest Airlines canceled over 16,000 flights, leaving more than 2 million passengers stranded.
While severe weather was the catalyst, Southwest’s outdated scheduling systems—burdened with years of technical debt—magnified the crisis. The airline’s outdated scheduling systems struggled to effectively match available crew members with planes that were ready for departure.
This cost the airline about $600 million in refunds and reimbursements, as well as an additional $140 million in penalties from the U.S. Department of Transportation.
Short-term and long-term costs of failing to gauge technical debt or remediation efforts
Having explored some real-world examples of technical debt downing giants, like David versus Goliath, let’s take a quick look at some of the other short- and long-term costs associated with unassessed and undetected technical debt.
Short-term costs: The risks of technical debt pre-acquisition
1. Overvaluation
One of the biggest private equity challenges in software investment is knowing how to accurately value tech companies.
Indeed, Bain has officially branded 2023 as “the year that buyers and sellers couldn’t agree on valuations.”—underscoring the importance of understanding hidden liabilities like technical debt.
Unassessed technical debt inflates acquisition costs, as it obscures the true value of the asset. Without visibility into what lies beneath the surface, investors risk overpaying for software that demands costly remediation.
2. Renegotiations or deal failures
Technical debt that emerges during due diligence can disrupt deal negotiations, leading to last-minute renegotiations or, in the worst-case scenario, the abandonment of the deal. This creates additional challenges in an already complex M&A process and jeopardizes investments, which depend on smooth integration and prompt value creation.
Long-term consequences: The risks of technical debt post-acquisition
1. Low ROI
Discovering technical debt post-acquisition drains resources that weren’t accounted for—slowing returns and potentially leaving investors short of expected performance.
2. Operational inefficiencies
Technical debt often presents itself in inefficient code or code architecture, which can hinder both scalability and growth of the asset. In private equity, this poses a big problem, since software scalability is crucial to value creation.
3. Delayed time-to-market
If your value creation thesis involves adding new, innovative features to a software asset, technical debt acts like a massive obstacle you’ll need to overcome before those features can hit the market. Delays in time to market translate to postponed ROI, frustrated stakeholders, and potential harm to your brand’s reputation.
4. Cybersecurity vulnerabilities
Technical debt often results in poor-quality code that leaves software vulnerable to breaches and attacks. For PE firms, this means exposure to financial losses, reputational damage, and regulatory penalties.
5. Regulatory non-compliance
As technology advances quickly, especially in the field of Artificial Intelligence, regulations governing software quality, transparency, and risk management are becoming increasingly strict.
Non-compliant code—if overlooked during due diligence—can result in significant financial penalties, legal liabilities, reputational harm, and costly remediation efforts post-acquisition. Failure to address technical debt could jeopardize the long-term value of the investment, making it critical to assess compliance thoroughly.
Best practices for addressing technical debt in Private Equity Due Diligence
As we stated earlier, the problem is not that software assets have technical debt, but that without a thorough assessment, it’s impossible to tell how bad the tech debt problem is and make a cost-effective plan to mitigate it.
In other words, tech debt doesn’t necessarily make an asset unviable or unprofitable, but can impact the valuation, investment thesis, and ROI.
Crucially, private equity professionals must understand that early assessment of technical debt –coupled with the creation of a well-triaged remediation plan– can leverage debt into a value creator.
Five key technical debt assessment private equity strategies
Employing certain best practices for mitigating technical debt, as outlined below, is how private equity firms can turn hidden problems into clear challenges that can lead to calculated opportunities.
1. Treat tech debt as a business issue
Reframe technical debt as a financial challenge rather than a technical problem. Triage remediation based on cost impact and prioritized efforts that maximize ROI while controlling the total cost of ownership.
2. Conduct source code analysis
One of the most beneficial measures you can take is to conduct an in-depth source code analysis. The aim of the analysis should be to tangibly quantify the technical debt involved, with particular focus being given to especially high-risk, high-cost areas.
3. Evaluate the scalability and future-proofing of existing systems
Assess whether the software can scale with demand or adapt to emerging technologies. Scalability is a critical driver of valuation and growth strategies, and understanding its limitations enables more accurate road mapping.
4. Prioritize critical debt remediation pre-close
One of the major risks of hidden technical debt in an asset is being unprepared for the high remediation costs associated with ‘fixing’ the software post-acquisition. You can mitigate this risk by getting ahead of the game and prioritizing the remediation of the costliest debt areas in your post-acquisition management plan.
In doing so, you ensure that your assets are brought ‘back on track’, so to speak, to secure target ROI as soon as possible.
Note: Avoid value-creation strategies aimed at reducing technology debt to zero or tackling all areas of tech debt at once. The likelihood is you’ll never be able to completely eradicate the ‘tax’ of an asset. Instead, you should direct your energies to only those most devaluing, costliest aspects of the debt.
5. Embrace technical debt management
The single best way to turn tech debt into value is to account for its cost in your growth strategy and establish technical debt management practices that will help you reduce technical debt where it matters most.
Conclusion
Technical debt, when left unassessed, is a silent killer of valuations and ROI. However, with early identification and a clear remediation strategy, it can be transformed from a liability into an opportunity.
By conducting thorough assessments during due diligence, private equity professionals can avoid overpaying, mitigate risks, and create actionable growth plans that maximize returns.
By addressing technical debt early, PE firms can unlock smarter acquisitions, protect valuations, and accelerate ROI—turning a hidden liability into a competitive advantage.
For more information, or assistance in technology acquisitions, get in touch with the team at Software Improvement Group today.
