Operational Due Diligence: A Guide for Singaporean Businesses

Organizations all around the globe have to face different types of operational threats like cybersecurity issues or suppliers’ monopolies. The type of operational threats may vary from business to business. For example, 75% of survey participants quoted that cybersecurity is the primary operational threat to the banking industry.

Such operational risks will be transferred to potential buyers in the case of M&As or other financial transactions. This is where operational due diligence (ODD) becomes a necessary part of such business deals. ODD identifies the potential operational risks in the target company and how they can affect the buyers.

Here is a detailed guide on operational due diligence and how to conduct it.

What is operational due diligence?

Operational due diligence (ODD) is one of the most important types of due diligence, which primarily investigates the operational processes of the target company. Potential buyers or investors investigate the operations of the target company and any possible risks attached.

ODD involves investigating different operational components of the target company. It may include examining controls, systems, processes, and management practices. ODD helps understand how well the target company manages its business and whether any potential threats can affect the operations in the future.

It is important to note that operational due diligence also focuses on prospects rather than evaluating past performance only.

Consequently, ODD is an essential part of M&As that affects the decision-making process significantly. 36% of private equity managers and 38% of corporate dealmakers consider operational due diligence a key component of successful deals.

The process itself is complex and daunting, but using due diligence data room software can make the process faster and safer.

Objectives of operational due diligence

Operational due diligence in private equity transactions or M&A deals is conducted with the following key goals in mind.

Risk assessment

ODD assesses a target company’s value creation ability in the future by reviewing its current operations. It aims to assess operational risks within a target company or fund and helps identify investment risks like:

Regulatory issues
Financial controls
Cybersecurity

Operational due diligence helps address problems early by assessing potential risks in advance. This ensures a smoother transaction process and minimizes surprises for the buyer or investor.

Compliance assessment

It determines if the target company’s operations follow applicable laws and industry standards,like:

Value creation potential

Operational due diligence assesses how improvements in the target company’s operations can help maximize the deal output. It identifies key areas where changes could lead to higher efficiency and profitability. This helps buyers or investors achieve better performance and higher returns on investment in the long run.

Operational efficiency evaluation

ODD aims to evaluate how good the operations are in the target company. The due diligence team may examine:

Processes
Systems
Technology
Organizational setup

Key components of operational due diligence

Key components of the operational due diligence process include:

1. Organizational structure and management

The structure of the target company says a lot about its decision-making efficiency and operational stability. It is important to evaluate three key areas of the management teams:

Skills
Experience
Leadership style

It helps assess how well the team can address challenges and ensure corporate growth.

2. Operational processes and systems

Well-structured operational processes directly affect an organization’s efficiency. A thorough assessment of different operational processes like logistics and supply chain management helps determine operational inefficiencies. ODD also focuses on evaluating the integration of information systems and technology.

3. Financial performance and cost management

A detailed analysis of a company’s financial statements gives a clear picture of profitability and cost structures. When you deeply understand the expenses and revenue streams, you can easily identify areas for cost optimization. A solid financial management strategy increases profitability and long-term sustainability.

4. Risk management and compliance

Businesses face risks, but how they address them is important. That is why operational due diligence focuses on assessing risk management frameworks.

ODD helps assess how well the target seller complies with legal business practices and industry regulations. For instance, if the company is situated in Singapore, does it comply with cybersecurity standards set by the government?

5. Customer and supplier relationships

Strong relationships with suppliers and customers are a sign of business stability. Operational due diligence helps assess whether there are any risks involved in the supply chain. For example, overreliance on one supplier or customer can lower the bargaining power. Understanding these dependencies during the operational due diligence process helps in better risk management.

Operational due diligence process

An adequate framework and systematic due diligence process ensure your due diligence team is doing the job correctly. An operational due diligence checklist might be very helpful and is usually provided by high-end data room providers. Here are some important steps in the process.

Step 1: Planning and preparation

The first step in the process is to define the scope and goals of the due diligence clearly. What is your primary point of focus? Are you focusing on the supply chain more than the technology, or vice versa? Once you are clear about the goals, it is important to assemble a team of professionals. They may include operation specialists, legal experts, tech pros, or financial experts.

Step 2: Data collection

The next step in the process is to collect operational data. You can request access to previous data or conduct interviews with stakeholders or important personnel. You may ask for company review reports for the last five years, audited financial statements, and copies of annual reports.

Step 3: Analysis and evaluation

Detailed data analysis in the next step after data collection. There are different ways to evaluate company data. For example, you can use the SWOT model or compare operational metrics to industry standards. This will allow you to identify areas for improvement.

Step 4: Reporting and recommendations

Finally, the due diligence team needs to prepare a detailed report and summarize the findings in ODD. It is important to include actionable recommendations and strategies to address the risks in the report. These strategies will be helpful in bettering the company’s operation after the completion of the transaction.

Challenges in conducting operational due diligence

The ODD process is not always straightforward and comes with its fair share of different challenges. Here are some of them.

1. Data accessibility and quality

Data is like a lifeblood in this process, and inaccurate or missing information is a key challenge in operational due diligence. Data accessibility remains a major issue as well.

Companies can minimize these hurdles by employing a virtual data room for investors, private equity transactions, or M&As. It allows remote and immediate access while requesting and sharing missing records with ease.

2. Integration complexities

It is always difficult to integrate different workflows, processes, and IT systems after the merger or acquisition. Inefficient integration leads to data inconsistencies and may raise other inefficiencies.

It is better to do a proper IT assessment to determine compatibility issues and then create a framework accordingly. Using automation tools and middleware solutions can be helpful.

3. Cultural and organizational differences

Cultural and organizational differences are a huge headache in the ODD process. Management approaches, benefit plans, or work ethics may differ.

It is necessary to conduct a thorough cultural assessment of the target company and buyer. Identify the differences between both cultures and create a framework to minimize them. Listening to employees and their concerns must be a mandatory part of the cultural assessment.

4. Regulatory and compliance issues

Compliance with the regulatory standards can be challenging. The problem becomes worse in the case of cross-border transactions. It is important to have a team of legal advisors so that they can build a strong compliance framework for a smoother ODD process.

Best practices for effective operational due diligence

A proactive approach can help make the operational due diligence phase more effective. Here are some tips for better ODD:

Always hire experts early in the process. They are better trained and experienced in addressing the challenges that arise during due diligence and can identify operational risks with ease.
Make and implement comprehensive and well-structured evaluation frameworks. Use operational due diligence checklists prepared by experts so that you do not miss out on anything.
The evaluation process should not be limited to the due diligence phase only. It is necessary to monitor implementation progress in the post-merger phase and make changes accordingly.
Employ advanced solutions like virtual data rooms for better data accessibility and analysis. These platforms allow the target company, buyers, and other stakeholders to collaborate via digital routes.

Conclusion

Operational due diligence is a type of due diligence that deeply assesses the operational aspects of the target company. It plays a vital role in understanding the operational health of the company by identifying:

Operational inefficiencies
Potential risks that may affect the profitability and value creation
Regulatory problems
Financial risks
Cultural and organizational differences, and
Possible integration challenges

Early identification of the above-mentioned and other possible risks helps private equity firms, investors, and buyers make more informed decisions.