casemark/conducting-operational-due-diligence

Conducting Operational Due Diligence

Structures operational diligence across management assessment, systems and infrastructure evaluation, operational risk identification, and post-close integration planning for PE, VC, and growth equity transactions.

When To Use

• Evaluating a target company's operational readiness prior to LOI or definitive agreement
• Assessing management team depth, capability gaps, and key-person dependencies
• Reviewing IT systems, ERP platforms, and data infrastructure for scalability and integration risk
• Identifying operational risks that affect valuation adjustments or deal structure
• Building a Day 1 / First 100 Days integration roadmap

Inputs To Gather

• Management & Org Data: Org charts, leadership bios, employment agreements, compensation structures, retention arrangements, reporting lines
• Financial Operations: Monthly close process timeline, AP/AR aging, cash conversion cycle data, budget-vs-actual variance reports
• Systems & Technology: ERP/CRM platform details, IT architecture diagrams, cybersecurity audit results, software license inventory, disaster recovery plans
• Operational Metrics: Unit economics, capacity utilization, throughput rates, defect/return rates, SLA compliance data, customer churn
• Legal & Compliance: Pending litigation, regulatory filings, environmental permits, insurance coverage summaries [VERIFY jurisdiction-specific requirements]
• Customer & Supplier Concentration: Top 10 customer revenue breakdown, top 10 supplier spend breakdown, contract renewal schedules, single-source dependencies

Workflow

1. Define Scope & Prioritize Workstreams

   • Align diligence scope with deal thesis — focus effort on the 3–5 operational areas most critical to the investment thesis
   • Assign workstream leads (management/HR, finance ops, IT/systems, commercial operations, supply chain)
   • Set timeline with interim checkpoints tied to deal milestones

2. Management & Human Capital Assessment

   • Map organizational depth: identify single points of failure and bench strength below C-suite
   • Evaluate management track record against stated KPIs for prior 3 years
   • Assess cultural alignment with acquirer or portfolio operating model
   • Flag key-person risk and determine whether retention packages or replacement hiring is needed pre-close

3. Systems & Infrastructure Evaluation

   • Inventory all core platforms (ERP, CRM, HRIS, BI tools) and assess version currency, customization debt, and vendor lock-in
   • Review IT security posture: penetration test results, SOC 2 status, incident history [VERIFY whether SOC 2 Type II or equivalent is standard for target's industry]
   • Evaluate data quality and reporting reliability — can management produce accurate financials within 10 business days of month-end?
   • Identify integration complexity: number of systems requiring migration, API availability, data migration effort

4. Operational Performance Deep Dive

   • Benchmark unit economics against comparable portfolio companies or industry medians
   • Analyze capacity constraints and CapEx requirements to support the growth plan in the model
   • Review supply chain resilience: supplier diversification, lead times, inventory policy, and logistics cost trends
   • Assess customer concentration risk — revenue from top 3 customers exceeding 30% warrants specific mitigation planning

5. Risk Identification & Quantification

   • Categorize findings as: (a) deal-breaker, (b) valuation adjustment, (c) post-close remediation, or (d) acceptable risk
   • Quantify financial impact where possible — e.g., deferred IT CapEx, unfunded compliance obligations, pending litigation exposure
   • Map risks to specific reps & warranties, indemnification provisions, or escrow requirements in the purchase agreement

6. Integration Planning

   • Draft Day 1 readiness checklist (payroll continuity, insurance binders, bank account transitions, IT access)
   • Outline First 100 Days integration plan with responsible owners, milestones, and dependencies
   • Identify quick wins (cost savings, vendor renegotiations, process standardization) vs. longer-horizon transformation initiatives
   • Define KPIs and reporting cadence for post-close operational monitoring

Output

• Operational Due Diligence Report organized by workstream, containing:
  • Executive summary with go/no-go recommendation and key risk callouts
  • Workstream findings with supporting evidence and severity ratings
  • Quantified adjustments to enterprise value or working capital peg, where applicable
  • Risk register with owner assignments and mitigation timelines
• Integration Roadmap with Day 1, Day 30, Day 60, and Day 100 milestones
• Management Scorecard rating leadership across execution, strategy, culture fit, and retention risk

Quality Checks

• Every material finding is supported by a specific data source or management representation — no unsourced assertions
• Quantified impacts tie back to the financial model or quality-of-earnings analysis
• Key-person and concentration risks are explicitly flagged with mitigation recommendations
• [VERIFY] Regulatory and compliance findings are validated against the target's operating jurisdictions
• Integration plan accounts for deal structure specifics (carve-out vs. full acquisition, platform vs. add-on)
• Report distinguishes clearly between confirmed findings, management representations not independently verified, and open items requiring further diligence