Overview of Operational Due Diligence
A buyer (acquiring company) has to carry out due diligence on the target company. Operational due diligence comes as a part of a fully-fledged due diligence package for the target company. In this form of due diligence, the buyer comes to know the operational specifications of the target company. Different industry areas have different approaches for carrying out operations due diligence.
A third-party management consultant performs operational due diligence. It is crucial that expert professionals perform this process, as knowledge in the relevant field is essential. In operational due diligence, the target's operational structures would be evaluated from the buyer's perspective. The buyer will come to know if there any form of risk present in the target. This would provide the buyer to either:
- Reconsider the Deal;
- Negotiate the Price of the Target Company; and
- Walk out of the deal without any negotiation.
In a merger or acquisition scenario, the buyer has the objective of receiving optimum returns from the target company. A company enters into a merger transaction with another company to improve its overall performance and economies of scale. Hence, it is beneficial for the company to conduct an operational due diligence process to understand the performance of the target company.
What are the Objectives of Operational Due Diligence?
Some of the main objectives of operational due diligence are:
- It would give confidence to the buyer to invest in the target company.
- Through operations due diligence, the operations of different departments of the target company are known.
- It will also provide a competitive advantage to the buyer.
- Operational Due diligence measures the amount of risk present in the potential acquisition. Through this, the buyer will understand if the target company is performing well.
- Analyzing the movement of the target goals and objectives can also be obtained through operational due diligence.
- Without having operations due diligence, the buyer would not know any internal issues within the target company. Many deals have not been successful due to improper operations due to diligence protocols.
- Operations due diligence covers all the departments. Hence the buyer will know all operational risks associated with the target company.
- Operational due diligence helps the parties to build a scalable and achievable business plan with well-defined goals and objectives.
Areas of Operational Due Diligence
The main areas where operational due diligence focuses on are as follows:
- Finances of the Target Company.
- Goals, Objectives and Strategic Planning of the Company.
- Observing the Strategies of Operation.
- Measuring the risks in different departments.
- Mitigating the risks and monitoring future performance.
Finances of the Target Company
One of the most crucial information required by the buyer is the finances of the target company. This would include the following:
- Statement of Annual Accounts of the Company.
- Periodic Returns filed by the company.
- Statutory Reporting and Disclosures of Quarterly and Yearly audits of the company.
- Profit and Loss Information about the target company.
- Assets and Liability position of the company.
- Appointment of Auditors for the target company as per the Companies Act 2013.
- Consolidated financial statements of the target company.
- If the target company has any subsidiary, then financial statements and reviews of the subsidiary company must also be provided.
Goals, Objectives, and Strategic Planning of the Company
A target that is performing well will have specific goals and objectives. The performance of the target company would be based on strategies and goals. Apart from this, the buyer would have to look into the following:
- Goals of the Company.
- Management objectives of the company.
- Information on previous objectives of the company. Report on objectives achieved by the organization.
Observing the Strategies of Operation
Synchronization is the practical key to align all the strategies of the target with the buyer. To understand the target company's operational strategy, the buyer has to analyze and observe the current working environment of the target company. All departments have to function properly to understand if there is efficient synchronization within the company.
- Observe and measure the coordination between the upper management and the lower management of the company.
- Understanding the hierarchy of the organization.
- Accounting functions, Human Resource Functions, and Supply chain function working effectively in an organization.
- Planning and Coordinating Functions of the Company.
Measuring the risks in Different Departments
Risk analysis is a crucial element for an organization to develop. An organization needs to measure and evaluate the number of risks of all departments. In operational due diligence, the buyer will have to evaluate the target company's total risk. Through this, the buyer will understand if there are any operational inefficiencies in the target company. Apart from this, the buyer will have to consider the following risks in the target:
- IT Risks such as cybersecurity breaches and data threats.
- Regulatory Risks.
- Financial Risks.
- Operational Risks.
- Performance Risks.
Risks in a company can be analyzed and measured as per quality assessment methods. Quality assessment methods are used to understand the standards of the risk present with the target.
Mitigating Risk and Monitoring Future Performance
Mitigation is required for any enterprise to avoid any risk. The buyer has to ensure that the target has developed protocols to mitigate any form of risk-prone in an organization. The organization can achieve this by implementing and following protocols. The buyer has to ensure that the target has to have the following protocols:
- Ensure the there is a practical cybersecurity framework within an organisation. This framework will mitigate and remove all the threats faced in the organization.
- Ensure that data protection protocols have been adhered to by the company. Compliance under GDPR (General Data Protection Regulation, 2018) and Personal Data Protection Bill, 2018, has to be implemented. By doing this, the buyer can make sure that no data breaches occur in the company.
- The buyer also has to ensure that the target company's financial systems are at an optimum level.
- Risk protocols implemented must be effectively monitored by the buyer. A protocol implemented must be monitored to check if this synchronizes with the activities conducted by the buyer.
Elements of Operational Due Diligence
Organizational Structure and Employees
While conducting operational due diligence, the buyer must ensure that there is proper coordination between the company's departments. This will include checking operations of all employees of the company. The following have to be overlooked by the buyer:
- Employee values.
- Leadership Skills, Motivational Tactics and Managerial Aspects of the employees.
- The level of delegation of hierarchy from management to lower-level employees.
- Departmental classification of the organization.
- Growth Plans of the departments.
- Employment Criterion of the target company.
- What is the corporate culture followed by the company?
- The organizational structure followed by the company, whether it is the matrix or the hierarchical organizational structure.
- All these have to be conducted by the buyer to ensure that the organization values, employee culture, and corporate culture followed by the target.
Software and IT Infrastructure
Software is crucial for the proper functioning of an organization. Integration between different departments depends on the software used by an organization. The buyer must ensure that the target has sufficient IT architecture within the target company. Having this will ensure that the buyer is not susceptible to any software and IT related threats and breaches. The buyer has to ensure the following:
- Proper Operating IT infrastructure is present in the company.
- Data Protection Protocols is effectuated within the company.
- The target company follows cybersecurity frameworks.
- Systematic checks have been carried out within the company.
- Recovery Management and Data Management Systems are present in the company.
- The company has implemented disaster management.
All Assets and Related Costs of the Target company
Costs are one of the most crucial factors that drive a business. Cost Asset Management is a key area which a business utilizes to understand operational efficiency. The buyer has to make sure that the target has sufficient costs to meet daily expenses. Apart from this, the buyer also has to make sure that the asset quality meets optimum levels.
- Check the number of assets owned by the company.
- Valuing the assets as per the international standards of valuation.
- Calculating depreciation on the assets of the target company.
- Assets would also include intangible assets of the company, such as trademarks, designs, and copyrights. The buyer must make sure that the value of such assets is not affected in any way, such as data breaches in the past or reputational loss to the company.
Amount of Potential
The potential for the development of the target company would be measured by the buyer. The buyer has to ensure that the target has some form of resalable. This will help the buyer increase revenue and generate long term gains for the company.
By measuring this, the buyer will get a broad understanding of the target company can adapt to certain changes in the market. Based on the strategy adopted by the target company, the buyer can have a scalability analysis. This will help the buyer to understand if the target can face risks in the market. The common risks present in the market will include technology risk, economic crisis, and competition.
Amount of Risk
There are different risks associated with the target company. Apart from this, there is also a business risk that the buyer will have to face when an acquisition is over. Operational Due diligence is carried out to counter any form of risks present with the target company. By conducting this, the buyer can rethink the purchase price, which would be given to the seller. The buyer must consider a thorough analysis of the apparent risks present in the target and act accordingly.
Enterslice Benefits -Operational Due Diligence services
- We have experience in carrying out Operational due diligence services to assist your company find out any issues in the transaction.
- We have multifaceted teams of professionals comprising Chartered Accountants, IT professionals, lawyers, and company secretaries.
- We have extensive experience in handling matters related to mergers, taxation, and accounting matters in India.