Why investors can't afford to leave Operational Due Diligence out of the mix.... 
​​Any investor, or fund manager, understands the importance and process of Due Diligence (or DD) for the purpose of being able to make informed decisions before deciding to buy a business. However, DD has been (and still is to a large degree) focused only on assessment of a potential investment financial performance along with a general overview. An important aspect which is missed more often than not is that of Operational Due Diligence. The assessment of a business's operational efficiencies can offer important value which potential buyers or sellers need to have in order to make informed decisions.  


"Operational due diligence (ODD) is the process by which a potential purchaser reviews the operational aspects of a company of interest"


Let's look at some of the areas of ODD that will allow an investor to understand the level of operational risks a business has. This info, along with the financial and general investment DD results, forms the basis from which an investor is able to make informed decisions:

Operational Due Diligence | PEOPLE

The overarching objective would be the
assessment of the people employed in that
business. Verifying whether they have the
necessary experience (and qualification if that
is a role requirement) and the levels of
compensation relating to roles and
responsibilities in that business. Whilst this is
a people focus, the assessment requires a
financial layer to understand the structure of the business and how human capital costs are distributed.

Operational Due Diligence | PROCESSES

A well-run business is one that has the
necessary processes and systems in place
that enable a smooth and cost-effective flow
of work. A business that has weak processes
and systems hinders its ability to prevent, or
quickly deal with, any possible problems. 
A problem which, if continues unidentified,
may drag on for years and present significant risks to the overall business. Therefore the assessment of the effectiveness of the processes is a critical step in the decision to buy or sell a business. 

Operational Due Diligence | POLICIES

No business will claim that ethical standards
and operating practices are not important. 
However, we know that businesses are, at
times, taking advantage of clients or service
providers. For example, marking up the costs
of a service for a client that deviates from a
standard margin, simply because they feel
they can get away with it and, as a result,
see a quick increase in profitability. More often than not, these go unnoticed by the client.  
In a proper due diligence, it is important to ask and answer the question, “What is the business's ethical track record?” This question can be answered by evaluating historical data of cost vs output.  
Any investor will want to know if the business they are looking to acquire has that ethical compliance history. In the absence of this, there is a big risk of exposure to non-ethical practices by clients and or partners. Important information for any potential buyer.  

Operational Due Diligence | SUPPLIERS 

Most businesses outsource at least some of
their operations due to limited internal
resource or for cost saving purposes. It is
important to verify whether the service
providers are delivering the services promised
and if they are in the best interests of the
clients. This requires due diligence
assessment of supplier costs and delivery
standards to ensure that they too fall within the same ethical,
cost-effective and delivery quality standards expected. It is also important that a partner supplier is the right supplier to be handling the specific kind of work required to be carried out.  
If a supplier does not comply with the standards required by that company, this too may expose risk for future problems. 

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In summary, the process of evaluating a business for the purposes of a potential buy is a time consuming exercise. One which is generally more focused on all but the operational aspects of the business. This does not mean to say that traditional DD is any less critical for supporting decision making and needs to be rethought. It does however question if, in a tight financial economy, both locally and globally, DD can continue to do without ODD that sheds light on any significant operational risks of that business. 
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At Flusso we question a business’s ability to survive an increasingly challenging future if not constantly assessing, adjusting and getting better at the way things are done.
In the context of Operational Due Diligence, Flusso partners with Fund Management Firms and/ or Capital and Angel Investors to carry out the assessment in a business to determine the level of it's the operational risk. Critical information that needs to be added to the DD mix in order to ensure all risk is visible before a decision to buy, or not to buy, is made.



Writer:
Robin Hook | Flusso Consulting| Founder