By Gavin Fielden

How Sell-Side Operational Due Diligence Strengthens Financial Diligence

You’re only getting half the picture when simply focusing on the financials

When most investment professionals think about sell-side due diligence, it’s typically to do with quality of earnings, or Q of E. But a sell-side Quality of Operations® assessment is every bit as important to mid-market companies that want to realize the full potential of their enterprise value.

In truth, sell-side operational due diligence and sell-side financial (quality of earnings) due diligence go hand-in-hand. The operational evaluation strengthens the financial evaluation, ensuring that the value conveyed in the financials and projections—and the buyer’s level of confidence—are backed by a thorough examination of inventory controls, manufacturing efficiency, footprint strategy, supply chain optimization and other operational factors that contribute to EBITDA.

Sell-side operational due diligence is a forward-looking evaluation of the key operational areas of a business, qualifying and quantifying processes that are simply not covered in a financial due diligence evaluation. For example, a Quality of Operations® assessment can:

  • Identify a company’s excess capacity and the capability to use that capacity
  • Evaluate a company’s capability to scale
  • Identify areas for process improvement and cost savings
  • Call out risks that may (or may not) be identified in buy-side evaluations
  • Reduce the time to sale
  • Decrease the likelihood of surprises that can stall or kill a deal
  • Increase enterprise value

Unlocking future potential is critical

Overall, it gives the seller more structure around the narrative they are telling about the company’s current state and its future potential. When conducted by a reputable third-party firm with significant industry experience, it enhances credibility with prospective buyers. A comprehensive operational plan provides increased evidence that projected performance, savings and improvements are realistic.

For example, a $120 million food processing equipment company conducted a sell-side operational due diligence assessment with a focus on the company’s global operations. The evaluation team visited four manufacturing and research facilities in the United States and Europe. They assessed the supply chain and logistics, manufacturing processes and the cost structure. The team suggested cost-saving changes including facility consolidation and manufacturing process improvements that reduced cycle time and R&D costs. They also completed a detailed benchmarking study against similar companies. The results were dramatic:

  • Identified roughly $18 million in EBITDA improvements
  • Identified roughly $5.5 million in cash improvements

The insights and actions resulting from operational diligence has strengthened the company’s performance and in turn, strengthened its financials. This is not an isolated case. For example, a $185 million print distributor commissioned a sell-side operational due diligence evaluation to look at warehouse management and transportation systems. The assessment included interviewing key industry personnel, examining processes and systems and identifying complex and redundant management systems. The outcome was extremely beneficial—and all after a five-week engagement:

  • Identified roughly $16 million in EBITDA improvements
  • Found savings associated with a migration to an enterprise-wide Warehouse Management System
  • Established potential vendor and developed an implementation plan

Of course, most evaluations take longer than five weeks. While sell-side operational due diligence can be effective at almost any point before a sale, it is most effective when engaged 3 to 9 months prior. This allows for suggestions to be implemented so as to see the increased financial performance prior to the release of the Confidential Information Memorandum (CIM) to potential buyers. The current owner may choose to implement some suggestions prior to the sale and leave others as well-documented future improvements that are easy to articulate to prospective buyers.

It is important to have an experienced and credible evaluation team, with established systems to conduct an efficient evaluation. The process often includes site visits, personnel interviews and extensive communication with management. Ensuring the 3rd party will have credibility with potential acquirers is key. The result is a roadmap for current and future improvements, all of which have buy-in from senior management—a document that can be worth millions in additional value when buyers enter the picture.

Smart private equity investors know that conducting sell-side operational due diligence can enhance returns. It provides a Quality of Operations® perspective that can dramatically strengthen enterprise value, reduce risk, and expedite the transaction process. The assessment gives the seller confidence in financial projections and a solid plan for improvement, all of which make it dramatically easier to court buyers and expect a winning outcome.

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About the Author:

Gavin Fielden

Senior Managing Director
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