What Is Operational Due Diligence—And Why It Matters in M&A -

Posted by Jennifer M. Settles, Esq. | Jul 15, 2025 | 0 Comments

When most people think about due diligence in mergers and acquisitions, they picture teams of lawyers and accountants combing through contracts, tax returns, and financial statements. While legal and financial due diligence are essential, there’s another dimension that is just as critical—Operational Due Diligence (ODD).

Whether you’re acquiring a $2 million plumbing business or a $30 million tech company, operational due diligence is your chance to look under the hood and evaluate how the business actually functions day-to-day. It’s where you assess whether the operations are scalable, compliant, resilient—and ultimately, worth acquiring.

Why Operational Due Diligence Matters

Financial statements may show a company’s performance in the past, but operational due diligence reveals its ability to sustain that performance and perform into the future. Without this layer of diligence, buyers risk discovering post-closing surprises that can be costly to fix—or fatal to the deal.

Critical Questions ODD Helps Answer

ODD helps answer critical questions like:

Can the business run without the seller or other key individuals?
Are systems and processes built for scale—or barely held together with duct tape and heroic efforts?
Are key employees likely to stay, or are you buying a talent exodus waiting to happen?
Are there operational landmines (e.g., regulatory risks, cybersecurity vulnerabilities, cultural toxicity) waiting to explode?
What’s the true cost of bringing operations up to your standards?

What’s Included in Operational Due Diligence?

A thorough ODD process typically includes the following four steps:

Step 1: Document Review

Start by requesting and reviewing internal documentation that reveals how the company runs:

Organizational and Process Documentation:

Organizational chart and reporting structures (look for spans of control, decision-making authority)
Standard operating procedures (SOPs) for core processes
Internal reports and dashboards (what metrics do they actually track?)
Company-wide KPIs and how they’re measured
Meeting cadences and governance structures

HR and Personnel Records:

Employee handbooks and HR policies
Compensation structures, benefits, and bonus plans
Training programs and professional development
Turnover rates by department and role level
Performance review processes and documentation

Cultural and Leadership Alignment

Leadership team dynamics and depth of bench
Employee engagement and morale
Mission, vision, and values alignment
Willingness of current team to stay on post-transaction

Technology and Systems:

IT infrastructure maps and system architecture
Software licenses and subscription agreements
Data backup and disaster recovery procedures
Cybersecurity policies and incident response plans
Integration points between systems (often the biggest operational risk)

Business Continuity and Disaster Recovery

Backup systems and data redundancy
Cybersecurity protections and breach history
Disaster recovery plan and incident response preparedness
Insurance for business interruption

Customer and Vendor Relationships:

Customer contracts and service-level agreements (SLAs)
Vendor agreements and supplier dependencies
Customer satisfaction surveys and complaint resolution processes
Sales pipeline management and CRM usage

Compliance and Risk Management:

Regulatory compliance records (OSHA, environmental, data privacy, industry-specific)
Insurance policies, claims history, and loss runs
Internal audit reports and management letters
Legal disputes and regulatory actions
Compliance with new tax law

Supply Chain and Logistics

Vendor lead times and reliability
Inventory management systems and controls
Warehousing, shipping, and distribution capabilities
Tariffs, shipping costs
Vulnerabilities to disruption (e.g., single-source suppliers)

Facilities and Physical Assets

Condition and maintenance of buildings, equipment, and vehicles
Leased vs. owned assets
Environmental or zoning issues
Insurance coverage adequacy and history of claims

Intellectual Property and Proprietary Processes

Ownership and protection of proprietary tools, systems, or methods
Trademarks, copyrights, patents, and trade secrets
Use of open-source software (and compliance with related licenses)
IP assignments from employees or contractors

You’re looking for both completeness and coherence. Does the documentation reflect an organized, scalable operation—or a patchwork of ad hoc practices held together by institutional knowledge?

Step 2: On-Site Visits and Interviews

Operational due diligence isn’t just a paper exercise. Spend time on-site (or virtually) to observe how work is actually done. Meet with:

Leadership Team:

Executives, department heads and team leads
Ask about their biggest operational challenges and resource constraints
Understand decision-making processes and approval authorities

Front-line Operations:

Production workers, customer service reps, technicians
Ask: “Walk me through how you handle a typical order/customer/project”
Look for workarounds, manual processes, and pain points

Specialized Functions:

IT and compliance personnel
Key sales and customer service representatives
Quality control and safety managers

Key Questions to Explore:

Do their day-to-day descriptions match what’s in the SOPs and org charts?
Are informal practices deviating from written policies?
Are any mission-critical tasks handled by a single, indispensable person?
What happens when key people are out sick or on vacation?
How do they handle peak demand periods or crisis situations?
How are they planning for uncertainty regarding tariffs, supply chain issues?

Step 3: Background Checks and Third-Party Validation

In some cases, it’s worth going further:

Personnel Verification:

Conduct background checks on key individuals, particularly in regulated industries
Verify professional licenses and certifications
Check references from previous employers or business partners

Independent Technical Assessments:

Engage cybersecurity firms to audit IT infrastructure and data protection
Hire HR consultants to review compliance with employment laws
Bring in industry specialists to evaluate operational efficiency (e.g., lean manufacturing experts for production facilities, value engineering)
Commission customer satisfaction surveys or market research

Financial and Operational Audits:

Inventory counts and valuation assessments
Quality control testing and compliance audits
Environmental assessments for manufacturing, industrial businesses, or real estate

These additional checks add an objective layer to your diligence and help avoid blind spots that internal interviews might miss.

Step 4: Analysis and Synthesis

Finally, connect the dots by creating a comprehensive operational assessment:

Risk Assessment:

What operational risks and bottlenecks exist?
Which systems or processes could fail under stress?
What regulatory or compliance issues need immediate attention? Attention on the horizon?
How dependent is the business on key individuals?

Investment Requirements:

What areas or assets will need immediate investment or restructuring?
What’s the cost of bringing systems up to your operational standards?
Are there deferred maintenance or upgrade costs not reflected in the financials?

Value Creation Opportunities:

Where is the hidden value—underutilized assets, strong culture, scalable systems?
What operational improvements could drive growth or margin expansion?
Are there opportunities to consolidate or optimize operations?

Integration Planning:

How will this business integrate with your existing operations?
How will you physically and effectively transfer the assets?
Can you operate this business better than the current owner?
What’s your 100-day plan for operational improvements? 1-year plan? 5-year plan?

Red Flags to Watch For

Certain operational warning signs should give any buyer pause:

Over-dependence on founder/key employees: If the seller says “I’m the only one who knows how to…” you’re buying a job, not a business
Lack of documented processes: Institutional knowledge that exists only in people’s heads is a major risk
Outdated technology: Systems that “work fine” but can’t integrate or scale
High employee turnover: Especially in customer-facing or technical roles
Regulatory compliance gaps: Past violations or unclear compliance procedures
Customer concentration: Heavy dependence on a few large customers
Deferred maintenance: Equipment, systems, or facilities that need significant investment

Real-World Examples of ODD Failures that Could Have Been Avoided

Example 1: The Irreplaceable Employee

A private equity firm acquired a profitable manufacturing company, only to discover post-closing that 80% of customer orders were processed manually by one employee nearing retirement. When she left six months later, order fulfillment ground to a halt, costing the buyer hundreds of thousands in lost revenue and emergency system implementation.

Example 2: The Revenue Reality Check

Financials showed strong recurring revenue, but post-closing analysis revealed that over 30% of “active” customers hadn’t made a purchase in 18+ months, and that many had been double-counted through manual recordkeeping. Thorough ODD would have caught poor CRM hygiene, lack of customer segmentation or engagement metrics, and lack of integration between sales and accounting systems.

Example 3: The Scaling Nightmare

The buyer acquired a service business with plans to expand regionally. But when trying to onboard a second location, they realized every process was undocumented and dependent on informal practices and workarounds known only to the founder. ODD would have caught the lack of process standardization or SOPs, the fact that operations were dependent on tribal knowledge, and the lack of performance metrics to assess scalability.

Example 4: The Supplier Surprise

The seller had a sweetheart deal with a critical supplier due to personal relationships. After the closing, the supplier refused to honor the same terms with the new owner, causing a 25% increase in COGS and slashing margins. Through ODD would have caught the lack of transferable vendor agreements, overdependence on single-source suppliers, and the lack of formal procurement processes or contracts.

Example 5: The System Crash

Within a month of closing, the company’s core inventory system—written in outdated code—crashed. No one on staff knew how to fix it. A $75K emergency IT contract later, the buyer discovered the system hadn’t been updated in a decade. ODD would have caught the lack of IT infrastructure roadmap, unsupported or undocumented legacy software, and the lack of a disaster recovery or continuity plan.

Example 6: The Culture Crisis

Within 60 days of closing, employee turnover spiked. Exit interviews revealed longstanding management issues, harassment complaints, and burnout that had been suppressed during diligence. ODD would have caught weak HR policies and absence of formal grievance mechanisms, high turnover masked by year-end headcount, and poor morale and toxic leadership culture.

Conclusion: Don’t Skip ODD

Buyers who skip or minimize operational due diligence often regret it. At best, they end up paying to fix someone else’s problems. At worst, they buy a business they can’t actually run.

The bottom line: A profitable business on paper might be an operational nightmare in reality. Smart buyers invest in thorough operational due diligence to understand not just what they’re buying, but what they’re signing up to manage.

At The Law Office of Jennifer M. Settles, we guide buyers through the legal aspects of M&A—but we also help them frame the right diligence questions, coordinate with operational experts, and spot red flags before it’s too late. We work with operational consultants, IT specialists, and industry experts who can dig deeper into specific areas of concern.

If you’re contemplating a business acquisition, let’s talk about how to make operational due diligence a central part of your process. The investment in thorough due diligence today can save you from costly surprises tomorrow. Contact us today at (602) 617-3938. The first consultation is always free.