What is operational due diligence?
Operational due diligence (ODD) is part of a due diligence process in which the potential buyer or investor reviews the operational aspects of a target company ahead of a merger or acquisition, private equity investment, or capital raise.This type of due diligence investigates the target's business model and operations to ensure the company is suitable for the buyer's goals and to identify how the company unlocks value from its operations.
Operational due diligence involves investigating aspects of the company’s operations, including:
- Operating processes and efficiency
- Supply chain, logistics and procurement
- Human resources and workforce strategy
- Technology and systems
- Financial performance and cost optimization
- Risk management and compliance
- Customer and supplier relationships
Objectives of operational due diligence
The objectives of operational due diligence include:- Enable the buyer to make informed decisions about the target company’s operations
- Identify operational bottlenecks and potential hazards
- Assess the level of risk in the transaction being considered
- Create a scalable and realistic business plan with clear goals and objectives for implementation post-acquisition.
What is assessed during operational due diligence?
Operational due diligence reviews and assesses key business areas critical to the company's day-to-day operational effectiveness.This usually includes the management team, operational processes, technology systems and customer and supplier relationships. Financial performance is also considered to measure how well operations are conducted.
Focus areas of operational due diligence
Operational due diligence identifies a company’s operational model's strengths, weaknesses, and potential risks. This enables informed decision-making during M&A and effective post-acquisition strategies to mitigate risk.Organizational structure and management
Operational due diligence includes assessing the organizational structure and effectiveness, including where improvements could be made. This step may be revisited and refined as the other aspects of operational due diligence are investigated.The management team's experience, skills and results are evaluated, along with any key person risk should a particular person leave the business.
Operational processes and systems
The efficiency and effectiveness of the supply chain, logistics and procurement directly affect the bottom line. All processes are examined, along with management systems, IT infrastructure, software and data security management.Market position and strategy
This step overlaps with commercial due diligence, considering how the company’s business plan and strategic objectives help achieve business success and align with the buyer’s goals.In this step, customer and supplier relationships are assessed. Contract terms and potential dependency risks are reviewed.
Risk management and compliance
Operational risks are identified and assessed. Compliance with applicable industry regulations and standards is reviewed. The risk management strategies and processes are reviewed.Human resources
The company’s behavioural model and corporate culture inform operational effectiveness and the application of policy and procedures. The workforce strategy, employee retention information and human resourcing practices are considered.Operational due diligence vs financial due diligence
Operational due diligence investigates the day-to-day effectiveness of a company while financial due diligence measures the company’s overall financial health.Operational due diligence reviews the supply chain, technology and human resources to ensure sustainability and scalability. Financial due diligence looks at the financial statements and accounting policies, cash flow and revenue streams, profitability and financial performance and any financial risks or irregularities.
Financial due diligence tends to look back over past performance to predict future performance. In contrast, operational due diligence looks forward to considering how the business's potential might be unlocked to create value.
Financial due diligence provides a clear picture of the company’s financial health, identifies financial risks and assesses the financial stability and growth potential. Operational due diligence provides insights into operational strengths and weaknesses, where operational improvements can unlock value and the scalability of the business model.
Why operational due diligence is important
The purpose of operational due diligence is to identify operational risks and opportunities to improve, assess the business's sustainability and scalability and evaluate the business model's effectiveness.It also assesses potential synergies with the acquiring company and can be instrumental in informing post-merger or post-acquisition integration.
Companies being acquired can prepare for a deal with in-house operational due diligence. Many deals fail due to issues that surface during the due diligence process, so if the sell-side can perform due diligence before the buy-side is involved, risks or red flags can be resolved before engaging with the buyer.
This can make the target company more appealing to buyers or investors, increasing the value of the deal or the amount of the raise.
Operational due diligence and private equity
Private equity and real estate investment firms undertake operational due diligence on investments. Fund managers then have the information they need to assess potential operational risks associated with the investment.Operational due diligence helps to ensure that the investment delivers the expected returns. An operational due diligence report surfaces any issues that could prevent sustainable business performance or growth, like IT system risks, supply chain factors or changes in the market demand.
What are the most common challenges faced during operational due diligence?
Thorough operational due diligence requires cooperation between the party preparing the report and the target company. It also requires a high level of organisation. The following limitations to successful and thorough operational due diligence are common but can be overcome with planning and using secure digital tools.Limited access to information
The historical processes and information storage practices of the target company may inhibit operational due diligence if records are inadequate, sensitive information cannot be easily redacted or there is a lack of robust data.Automated redaction and secure and specific file sharing inside a virtual data room can help overcome some of these issues. Companies considering raising capital or selling should adopt an ‘always on’ approach to data systems to ensure that when the time for due diligence arrives, the process is smooth and maximum value can be captured in the transaction.
Time constraints
There’s often a tight timeframe in which all types of due diligence, including operational due diligence, must be completed. Large volumes of documents may need to be summarised to ensure nothing is overlooked or missed during the operational due diligence assessments, paying close attention to any red flags or potential risks.AI-powered deal workflows and teams with expertise to assess each aspect of the business operations can efficiently complete operational due diligence and lower the likelihood of missing material information.
Lack of expertise
When a target company operates in an industry that the buyer or investor is less familiar with, operational due diligence must be overseen by a team or person with the right expertise. This is particularly relevant if complex or industry-specific operational processes and regulations exist, specialized technology infrastructure or intricate supply chain systems.Inadequate technology
Spreadsheets and email are commonly used but do not offer the traceability or security that benefits thorough operational due diligence. Using an advanced workflow in a secure digital environment can help improve visibility of the due diligence process, organize information effectively and improve the accuracy of the final report.These limitations to operational due diligence can be mitigated using a checklist and a digital workflow set up to capture complex information and processes.
Operational due diligence checklist
Buyers, investors or target companies can use an operation due diligence checklist to ensure nothing is missed when preparing for a deal. A checklist helps to surface the information that allows effective negotiations and decision-making.Our operational due diligence checklist covers everything you need to prepare or request when investing, buying or selling a company.
The complete ODD checklist will help to ensure nothing is missed during this critical process. Here’s a summary of what the checklist includes:
Initial operational due diligence overview
The initial overview is designed to save time by identifying any roadblocks or red flags early. It considers:- Synergy between the target and the buyer/investor
- Risks or red flags associated with the deal
- Quick wins that can generate value
- Capital investment required to improve target company operations
- Sustainability of target company operations
Document review
Once the initial overview confirms the deal is worth pursuing, the document review step verifies any assumptions and information provided.- Review internal procedures and compliance
- Check licences and subscriptions
- Review technology use
- Check intellectual property
- Review KPIs against market competition
Onsite assessment
The third step is to align what’s on paper with operations on the ground.- Confirm condition of assets, equipment and technology
- Interview operations managers
- Identify any backlogs or bottlenecks in process or supply chain
- Assess readiness for change and improvements
- Consider employee structure and culture
Identify and project value
The final step is to collate all the information into a final report and recommendations.- Identify where initial improvements can be made
- Build a budget and financial projection for operations
- Identify synergies and priorities for post-merger integration
Get the complete operational due diligence template now
Digital workflows can transform operational due diligence — here’s how to get started
Every company creates value in a different way, but with a robust operational due diligence process in place, buyers can rapidly identify the potential of a target company. Operational due diligence breaks down the company’s value creating processes to assess suitability and derive the acquisition price.Automating operational due diligence with Ansarada deals allows both parties to the deal to communicate and share information easily and securely. The workflow keeps each responsible team accountable to the process.
Questions about operational due diligence
What should be included in a due diligence checklist?
- A due diligence checklist should include:
- Historical financial statements
- Assets and liabilities
- Operational processes analysis
- Legal and risk analysis
- Evaluation of working capital and liquidity positions
- HR and business model analysis
- Supply chain analysis
What is included in a due diligence check?
A due diligence check reviews contracts, income, profit and loss, tax returns, customer and supplier agreements, and legal obligations.How to prepare a due diligence report
- Define the scope of due diligence
- Facilitate effective and secure information sharing between parties
- Analyse data for red flags or risk
- Organise information into comprehensive and summary reports
- Provide evidence-based recommendations.