Operational Due Diligence? Why bother? By Rutger Stolting (Partner @ Kwattaas) We’ve increasingly been getting requests from private equity parties to do an Operational Due Diligence. Investors want to be sure that their intended purchase can actually yield the return they’re aiming for. Because in the current market for take-overs there are often latent defects. We uncover them and make a solid action plan for the necessary improvements. What do we typically run into, and why is it so important to recognize these critical factors before your purchase? Seller’s market Any professional investor knows: we’re in a seller’s market. The pressure to invest is high and there’s a high demand for companies with potential. Reality is, however, that no object is perfect. Defects are usually not (only) financial in nature, but more often operational and organizational. Kicking the tires is therefore not enough. You need to check what’s under the hood and go for a test drive to be able to know for sure if the secondhand car you’re buying isn’t just looking good, but also drives well. Or in order to learn which repairs are necessary. Is it just a matter of changing a few wires and tubes, or does it need an entire new gear box? These factors do not surface with a traditional due diligence. They can, however, cost you serious money and even be of such a nature that they make the investment unwise. Improve your negotiation position Without an Operational Due Diligence certain defects only become visible after the transfer. These are some examples we’ve come across in our practice: An outdated machine park that could not keep up with the desired growth and even led to unsafe situations. A lot of unnecessary actions and ‘workarounds’, which led to inefficiency and a lack of overview. Outdated ICT-systems and an intended (necessary) ERP-implementation that would take a year at minimum and cost 100k. Too low, too high, or obsolete stock and faulty stock management. Limited internal communication and cooperation and subsequent inability to change. A management style and company culture that aren’t suitable for an upcoming phase of improvement and growth. A continued overstraining of people and resources, resulting in high urgency and expectation towards investments and expansions. In order to realize an investment goal by means of growth and return, you need a healthy organization with potential. When you’re aware of the overdue maintenance, you can do the math and know what you need to do to get everything on par. Such information is of great value in negotiations. Moreover, it’s the essential input for the validation and identification of the possibilities. Achieve growth quickly You make an investment, because you see possibilities; you want to make the company grow or create synergy with other property. But how do you know if that growth is actually possible? To assess this, we look at two different factors. Firstly, is the company operationally capable of realizing the growth? Are the machines capable, is ICT in order, can the people handle it? An example we’ve encountered: an investor decided a cultivation company could sell twice as much. However, the ODD showed that there was zero control over the cultivation process. The agriculturist couldn’t say how many seeds actually germinated and how many of those eventually grew fully. Accordingly, they couldn’t guarantee delivering the requested production. Do you find this out on T+1, you still have a long way to go. Do you find out before the take-over, then you can immediately start with improvements and make a realistic plan for growth. Secondly, can the current management handle the desired transition? And if you want to work with interim-management, what kind of person do you need? Our experience has shown us that a commercially driven leader often doesn’t have the right personality to tackle a dissatisfactory operational performance. In such cases you’re better off with a transition manager who’s solution-oriented, has insight and the management skills to get the organization in order. Save yourself the misery and the cost of the wrong person in the wrong place. The ODD brings to light the things the company needs to work on and what type of manager that requires. Why prior to the purchase? You could argue things will surface by itself after the deal and the portfolio manager will deal with it, or the new CEO. But that means you don’t actually know what you’re buying. Moreover, you lose out the opportunity of getting a better take-over price, plus you waste precious time. The ODD gives you a clear picture of the situation beforehand and you can put everything in position to be off to a flying start. Another great advantage is that an ODD shows your involvement and interest in the content. The people we speak to during an ODD includes the current management as well as people ‘on the floor’. They’ll be pleased with our (and your) interest in the content. It gives them confidence that the investor actually wants to build up the company and motivates them to contribute. Attention and understanding do wonders for good cooperation. This can’t be directly expressed in terms of money, but anyone who’s encountered resistance, knows how important such a level of engagement is. What it costs and what it yields. An ODD usually takes around two weeks. We will spend a couple of days on the ground in the company. This work is completely complementary to the regular due diligence. Your investment in us is therefore limited, and immediately yields money: at the negotiation table, and through a higher revenue from the day you get started with your new business. The ‘lever’ is huge. What’s keeping you? It’s up to you: would you buy a nicely polished car, kick the tires, and just see what happens on the first day? Or would you like to negotiate a good price, make a solid plan of action, and get to work with a motivated organization to realize the growth and results you’re aiming for? Are you an investor who does their own research? Or do you have a completely different approach? I’m very curious to hear about your experiences and would like to discuss your insights and findings. Would you like to learn more about our approach? I’d happily give you more information and references.