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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 truth.
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
Insights High --+-- Low
Practical High +---- Low
*Ian Mann of Gateways consults internationally on leadership and strategy.
