Operations Due Diligence, by James F. Grebey
Whether you are buying or preparing to sell a
brick-and-mortar business or a virtual online business, a technology business
or a service business, you need to perform a thorough due diligence to
determine the current status of the business.
A thorough due diligence process has three components:
Financial, Legal and Operations.
Financial due diligence is an assessment of the current
financial position of the business. As such it might indicate that the business
had exceeded its sales goals for the last two years. It would also explain that it had
accomplished this due to market improvements or because the company’s sales
process caused the business to improperly project sales.
Legal Due Diligence is performed to assess the legal facet
of the business by exploring its current legal status. It would include any
outstanding issues of ownership, pending legal actions, outstanding judgments,
liabilities, employee actions, insurance claims, intellectual property rights,
professional licenses, and so on.
A recent study showed that less than 10% of due diligence
was focused on the third component, Operations, but that over 40% of
acquisitions failed because of operational performance issues. It is the
Operations Due Diligence, author Grebey contends, that can ensure that you are
investing in a business capable of sustaining its operations into the future.
Consider the support given by the US government to the
automobile industry. Only an Operations Due Diligence could reveal whether it
was a case of returning a sick animal to the herd rather than curing it. The
automobile manufacturers were able to survive with the infusion of capital from
the government; however, without changing the way they operate, their demise
might have only been delayed. Time will tell, but for most investors, a
“time-will-tell,” or a “wait-and-see” approach means taking a huge risk.
Identifying weaknesses often provides a good reason for
investing. If, for example, you identify that the business has a weak sales
organisation, the investment plan could be to create an opportunity by putting
additional funds into the sales organisation after the acquisition. If the
sales team only has regional strength the merger with an organisation with a
national footprint might release significant value. It is the task of the
Operations Due Diligence to find the unrecognised potentials in a business.
An Operations Due Diligence can also be used as a management
self-assessment tool with significant benefits.
Managers who run their business as if it is always for sale
will be constantly trying to maximize its value for investors. By assessing
their own operations, managers are able to identify areas with latent risks and
opportunities, and they can use this information to prioritise limited
resources to target their process improvement needs. Business managers,
themselves, are also investors in the sense that they are investing their
professional reputations on the success of their businesses.
Employees who participate in the assessment are being made aware
of the need for change so they are less likely to be resistant to it.
Grebey makes an important distinction between the
“organisational structure” and the “operational infrastructures” when assessing
a business. Organisational structure defines the elements of the business, but
not how they operate. The organisational structure says there is an engineering
department. The operational infrastructure defines how the engineering
department operates and interacts with other departments.
“Infrastructures,” by his definition, cross organisational
boundaries spanning and supporting work as it progresses through all of the
organisational functions of a business.
He divides the operations infrastructure into eight areas:
customer satisfaction, production, information management, sales and marketing,
organisational, personnel, financial, and legal.
It is common for a Due Diligence to be performed to assess a
specific functional area of a business. Usually an investor conducts a
“Management Due Diligence” or a “Technical Due Diligence” with the goal of
assessing only this portion of the business. A true Operations Due Diligence
should not be limited to a single operations function. Rather, it should have a
broad scope that includes all of the operationals areas as any business is
organic not mechanical and every part affects every other.
Two cautions are necessary. The first is that there is no
one-size-fits-all Due Diligence, Diligence; every exercise is a subjective
assessment, guided by the needs and intentions of the investor. The second is
the caution to watch for the “BS Quotient,” (the Blarney Stone quotient.)
Kissing the Blarney Stone increases one’s capacity to flatter and stretch the
The Operations Due Diligence assessment report, the purpose
of the exercise, should state the facts as they exist, and suggests how to
seize what opportunities are revealed relative to the purpose of the exercise.
While the book is deeply informative and provides a guide
for performing an Operations Due Diligence it must be read with a warning. It
is not sufficient to guide a novice in doing the job whether it is for internal
purposes or for a purchase or merger. The book’s value lies in the insights it
will provide for those commissioning an Operations Due Diligence so that they
will be in the best position to ensure it is done thoroughly.
And, it must be added, with the frightening lack of emphasis
placed on Operations Due Diligence this book will definitely convince managers
and investors of the need for the exercise.
Readability Light --+-- Serious
*Ian Mann of Gateways consults internationally on leadership