Operational Due Diligence: What Buyers Look for in How Your Business Runs
When business owners think about due diligence, financial statements, tax returns, contracts, and legal documents usually come to mind. But a buyer is also trying to answer a more practical question: how does this business actually operate? Are the processes reliable? Is inventory well managed? Are there bottlenecks, hidden costs, or dependencies that could affect future performance? And can the business keep performing once the owner is no longer at the center of it?
That's what operational due diligence is designed to uncover, and it's an ExitReadiness® issue long before a buyer shows up. Looking at your company today through the eyes of a future buyer can reveal weaknesses while there's still time to fix them, reduce risk, improve performance, and uncover capacity you've already paid for but aren't using. Those improvements build value whether you sell in two years, hold for twenty, or pass the business to the next generation.
In this episode, Pat Ennis and Walter Deyhle welcome back Tim Van Mieghem, Founding Partner of The ProAction Group, which has helped middle-market companies and private equity firms uncover latent value since 1995. Tim explains how operational diligence differs from a quality of earnings review, why owner dependency is a risk whether the owner leaves or stays, how most companies can handle 20% more demand without adding overhead, and how AI is changing the way buyers evaluate operations.
Key Takeaways
A quality of earnings review is the appraisal. Operational diligence is the home inspection. The QoE tells a buyer what the business earns. Operational diligence tells them what they'll have to invest to keep it performing, and where hidden value lies.
Owner dependency is a risk whether you leave or stay. If the owner leaves, margins may compress or the buyer may need two or three hires to replace them. If the owner stays at the center, they become the bottleneck to growth. With 6 to 12 months of runway the fix is straightforward; with a week's notice it's an all-hands scramble.
Most companies are sitting on about 20% unused capacity. In Tim's experience, 49 of 50 companies could serve 20% more demand without adding overhead, not by working harder but by removing what's in the way. When volume grows and costs don't, margins don't just rise; they shift fundamentally.
Watch for workarounds. A company may say it runs on its ERP system while actually managing the business on dozens of spreadsheets. Roughly 80% of orders should flow through without manual intervention, so your people can focus on the complicated 20%.
Buyers pay for demonstrated performance, not projections. A spreadsheet showing what a buyer could improve is the buyer's return model, not your sale price. Make the improvements yourself and sustain them. One of Tim's clients expects to need six months of elevated results to get full credit.
Process fixes take weeks, not years. Unlike a new ERP system, process changes can be identified, designed, and put in place quickly. One manufacturer that believed it needed a new plant was running at roughly 40% of its real capacity and later kept growing without adding equipment or people.
The payoff is there even if you never sell. Owners start businesses for control and freedom, then lose both by staying at the center. One owner Tim knows went from handling 90% of her company's sales to 5%, and decided not to sell at all because the business became profitable and enjoyable to own.
AI is making operational diligence faster and less invasive. Buyers' advisors can now analyze full populations of data rather than samples and draw conclusions from a single site visit, so expect more scrutiny of your operations with less disruption.
Where to Start: Measure Your Best Day
Tim's first step for any owner is to look at variation in your own operation:
Find your high-water mark. What's the best day, shift, week, or month you've ever demonstrated, whether in production, shipments, quality, sales cycle, or forecast accuracy?
Compare it with your worst and typical days. The gap shows how much variation is built into the way you operate today.
Ask what would happen if every day were like your best day. That number won't tell you how to get there, but it sizes the prize. It's like surveying land for oil: it tells you the value is there so you know it's worth going after.
About Tim Van Mieghem
Tim Van Mieghem is a Founding Partner of The ProAction Group, an operational consulting firm that has served middle-market companies since 1995 by helping them identify, quantify, and uncover latent value. ProAction primarily serves private equity firms and their portfolio companies. Tim's expertise includes manufacturing, logistics, and inventory management, and is showcased in his book Implementing Supply Partnerships and his book Shocking Profit. He also hosts the Shocking Profit podcast.
Connect with Tim: LinkedIn · proactiongroup.com · shockingprofit.com
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Disclaimer: The information presented in this podcast is provided for educational purposes only. Neither the presenters nor ENNIS Legacy Partners are engaged to render legal, accounting, tax, or other professional services. Consult a qualified professional regarding your specific circumstances. ENNIS Legacy Partners assumes no legal liability for any loss related to information contained in this presentation.
Full Episode Transcript
This transcript was generated automatically and lightly edited for readability. It may contain minor errors.
Hey there, this is Pat Ennis of ENNIS Legacy Partners. Welcome to the ExitReadiness® PODCAST. I'm here with co-host Walter Deyhle. And our mission here on the podcast is to provide you, the business owner, with subject matter expertise on topics pertaining to building sellable or transferable business value and then for planning that eventual exit from your business. We want to help you build a business that can be transferred and then exit successfully on your own terms and conditions.
When most business owners think about due diligence, they tend to think, and rightfully so, first about financial statements, financial performance, tax returns, legal documents, and contracts. But a buyer is also asking a much broader, more practical question. How does this business actually operate? Can the company consistently deliver for customers, deliver that financial performance that we see in the financial statements? Are the processes reliable? Is the inventory managed well?
Are there operational bottlenecks, hidden costs, or dependencies that could affect future performance? And perhaps most importantly, can the business continue to perform after the owner is no longer at the center of it? These are all the kinds of things that we help owners look into and change over time. That's where operational due diligence becomes so important for a buyer. Operational due diligence is about understanding the risks and the opportunities as well that may not be so obvious from the financial statements alone.
And for an owner preparing for an eventual exit, there's an equally important lesson. You don't have to wait until a buyer begins asking these questions and expresses interest. You don't have to wait. Don't wait. Looking at your business through the eyes of a future buyer can help you identify any weaknesses that, if you address them now, can increase value and sellability, improve performance, reduce risk, and uncover opportunities to increase value long before you ever go to market or are approached by potential acquirers.
So today we're going to talk about operational due diligence and how understanding your operations can help you better control the company's future value, sellability, and transferability. And we have back with us our friend Tim Van Mieghem. Tim's a client. He's a friend. He's a strategic partner and just a guy that we love.
He's founding partner of The ProAction Group, which is an operational consulting firm that's been around since 1995 and helps middle-market companies identify, quantify, and uncover that latent value. The firm's primary focus is serving private equity firms and their portfolio companies. And Tim has personal expertise in manufacturing, logistics, and inventory management, as I mentioned a few minutes ago, and it's all showcased in his great book Implementing Supply Partnerships as well as his book Shocking Profit, which is the newer book. He's an author, by the way, too. And he's also the host of a podcast similar to this one called Shocking Profit, which we're big fans of.
And Tim believes, as we do, that operational excellence is a critical component of unlocking a company's sellable value. So Tim, welcome back to the podcast. Clearly, you're on the road. Yes. Exactly. We see your clothes hanging in the background.
You're a road warrior. That's right. Here you are with us. So, it's good to have you back with us. Good to see you. Thank you, Pat. Thank you, Walter. So glad to be here.
Great to see you, Tim. You know, Pat, rather than covering for Tim, I think we should just let him admit to the world that he's a homeless person living out of his car. He's living in a van down by the river. Exactly. Oh, actually Tim's a guy who would probably enjoy that. I might be driving my RV instead of my Jeep for that, but yes.
Yeah. Hey, Tim, let me get it started. You know, I think back to a number of years ago, one of the big buzzwords in due diligence was quality of earnings. Yes. And when it started out, you know, it was really quality of revenue. Are the people who are paying you your revenue financially stable?
Are your contracts automatically renewable, or do you have to bid them out? That type of thing. Yes. And then it kind of expanded, and part of this I think was brought on by the whole acknowledgment that companies really need to keep up with technology. So it really did become quality of earnings, and they would take a look at your expense items also, because you could kind of juice your earnings by forgoing some necessary capital expenditures or other spending in your systems.
So that became more of a drill-down on your earnings. This operational due diligence really sounds, in my mind, like the next step of that, where you're really drilling into how a company operates to see how truly sustainable their earnings are. Is that kind of the concept? That's a great way to put it, Walter. And oftentimes a way that really helps me with it is to compare it to real estate.
If you're going to go buy a home, you talk to your Realtor and they give you comps. They'll go and look at comparable homes to share with you what they're selling for. That in a way is similar to the QoE, the quality of earnings. That's saying, what is the value of the company? What are they earning when you take everything away after the revenues, and the quality of revenue like you said?
If you're buying a home, though, you'll also hire a home inspector. The home inspector isn't commenting on the value or the profitability, if it was a business, but rather what investments or work you will have to put in to maintain the current value, to maintain the current performance. So, it might be a beautiful home, and it's priced in line with other homes that are similar to it. And then when you go in and do the home inspection, you find something's wrong with the roof, there's mold in the basement, the appliances are old. In the home I bought a few years ago, they had done an addition and the wiring wasn't to code.
Those were all things that if I ever wanted to sell the house again, I'd have to fix them first. And that relates, like Pat brought up in the intro, to the issues that a buyer will look for. There's another aspect, though, that is not really captured well in this metaphor, which is the hidden value. This is something, especially today, private equity firms are chasing. They're competing to buy companies.
Thirty years ago, maybe 20 years ago, private equity firms could use a playbook where they'd come in, buy three or four similar companies, put them together, and get it to a larger size. They would end up with what they call multiple arbitrage, where they'd make their money; that's getting priced in. Today, private equity firms, to consistently perform, have to truly transform the company. They have to go in and help it actually scale, and do it well, for them to make their return. So the deeper diligence that you've both described is becoming much more common.
Yeah. So, hey Tim, let's just keep drilling down on that. Let's talk about what buyers are really trying to learn during operational due diligence, and then what gives them confidence, as they learn what they learn, that a business is going to continue to operate and maybe even go to the next level in performance after that owner exits. Yeah, great question. There's a whole host of them; we have 60 different risks that we test for when we're looking at a company.
And some of the big ones are, probably the biggest one is one you mentioned: how will this company operate? What will happen to performance? Will there be margin compression? Will we stress out the ability to fill orders well, fill the demand well, if the owner, who's about to get a life-changing check at some level, goes away? What if they exit the business?
What will that do? Certainly the business likely can survive it, but the buyer really does want to understand, is it going to stress out the margins? We saw an example a couple years ago where the CEO was heavily involved in operations. This was a manufacturing company. He was personally scheduling the plant.
He was personally directing day-to-day work and was involved in troubleshooting and things like that. There's a couple things in here, but one of them is he's been doing it for 40 years. It's his baby. He knows it like the back of his hand. If we have to replace him or her, will we be able to maintain the margins we have today?
Will we have to hire two or three people to replace what they're doing? Or will something be lost in translation? The good news is if you know this is a risk, then there's very straightforward work you can do, if you have six to 12 months to prepare for it. If you have to prepare for it on Monday, then it becomes an invasive, heavy, all-hands-on-deck kind of topic. Yeah, we think, based on our experience, that 6 to 12 months can be a short period of time, particularly in a scenario like you just mentioned, with a guy or a gal who's been at the helm for 20, 30, 40 years and they've got to change their role.
Oh, it's really hard. You're absolutely right. And it's interesting because there's two risks related to this topic. One risk is, what if the owner leaves? The other risk is, what if they stay?
Because there's a bottleneck to growth and to scale. And as ProAction's mentor and consultant, you know very well how much of a struggle it is even for me personally to get out of my own way. I've done things the way I've done them for so long. Right. So you're absolutely correct.
It's a big undertaking, and it really leads to, I think, another aspect of this that bears exploring. I'll go back to the home metaphor. When you're getting ready to put your house on the market, you redo the kitchen, you update the bathroom, you clean all things, you put in something new, and then how often do people say, "Dang, why didn't I do this when I moved in?" Yeah. Right. I don't want to leave now.
One thing we say all the time is, certainly, if you're planning to exit, you want to prepare these things so you get the best valuation on the exit. Even more important, though, is if you're going to run this company for 10 or 20 more years, or pass it down to kids or the next generation of leadership. Wow. Figuring this stuff out makes life so much better. Well, it does, doesn't it?
I mean, a couple of reasons entrepreneurs start a business to begin with is they want to have control. Yes. And they want to have freedom. Yes. But then as the business grows and becomes more and more successful, if they stay at the center, they lose both of those things.
They lose control and freedom. But if they do what you're talking about here today, they can regain or reclaim control and freedom, to the point where, if they're willing to continue to go to sleep at night with the risk, they might just hold on to it indefinitely, particularly if it's continuing to grow. Pat, I'm going to tell a story on you and Walter. The way I met you was through my sister, and my sister started a company, Draper Street, back in 2007. And I don't know, it was five, six, maybe seven years ago, she connected with you because she was exhausted.
She's like, "My kids are in high school. I'm spending so much time at work, and it's stressing me out. It's keeping me from living my whole life. I need to exit." And so you helped her prepare for succession, prepare for that exit. And I'll never forget this.
It was about a year and a half ago. We were at a family reunion. And you helped her go from being involved in like 90% of the sales to now being involved in 5% of the sales. She's done a phenomenal job. She's someone we refer to often because she really got it, but not only did she get it, she actually executed.
She developed the processes and her team on sales, and she did the same thing on operations and installation. And as I was mentioning, a couple summers ago we were at a family reunion talking about it, and I asked her, "How's it going? What's next?" And she's like, "Well, I'm not exiting." And I'm like, "Really? What happened?"
And she goes, "Well, we're making really good money, and now my job is my hobby." Yeah, she can be in France as often as she wants to be at this point. It's exactly right, Pat. Yeah, it's a good life. And the things you're talking about, and the role we like to play in this, is helping companies understand the size of the prize.
When you think about succession or an exit, you look at the risks or issues that a buyer might find and the hidden value. Understanding the financial impact, the impact on how well you can service your customers, your ability to grow, and on the life of your employees and your own life as the business owner, provides clarity around a good ROI: if I focus on this, here's what's possible. And it kind of leads to what ends up being, I think, one of the biggest issues that we identify, which is hidden value. It's understanding the true capability of your company. And the word that I want to talk about is velocity.
If I go to 50 companies and do an assessment, a tour, a walk-through, what have you, 49 of them have the ability to serve 20% more revenue, serve 20% more demand, without adding any overhead and maybe only a small amount of labor, relatively speaking. And it's not because people work harder. It's taking things out of the way, making it easier, actually accessing the capacity and the infrastructure you've already built. It's already there. And from a finance perspective, if I can handle 20% more demand without adding any costs, my margins shift.
They don't just go up, they shift fundamentally. Right. But Tim, hey, let me interject something. While you're in that process, and you're finding the hidden value, and you see that they've got strong bones, infrastructure in place, you're also looking for those systems and processes that are broken or need to be strengthened, right? The infrastructure or the foundation might be strong and in place, but there can be some systems and processes that need work.
It's exactly right, Pat. One of the words that really strikes me on this is "workaround." Here's an example. You ask somebody, "What kind of system are you on?" and they're like, "Oh, we're on NetSuite," or whatever it might be, and then we go in and walk through their process and they've got 50 Excel spreadsheets that they're using to actually manage the business. And I get it, and that's part of a good stage for developing a process, right?
But if you're using these kinds of manual one-off things to fill orders, that requires time and attention, and it interrupts the flow. And that's just on the system side. It's also true physically when we walk through a process: how many times do people actually have to stop and interact with it? Let's just say 80% of orders should flow through the system without being interrupted, slowed down, or waiting for manual input, because they're what you do every day. There's always going to be a sliver, 20% of your orders, that are complicated one-offs, what have you.
That's where you need to spend your time. I just love this part of it because it creates a very clear, palatable reason to go after the small improvements that open up the capacity that you already have. And it almost always relates to improving process. And here's the other one that's really wonderful: it also requires and opens up expanding the decisions, the ownership of people throughout the company, so that they own their part of the process. It may feel like a subtle difference, but it is so meaningful when people become part of problem solving instead of reacting, going from firefighters to problem solvers.
Well, Walter, it seems like you have a question. Yep. You know, I don't know if this is a common misperception out there, but I've encountered it a few times with clients thinking about selling their company. The most extreme I had was this guy who was, I guess, an engineer by trade, and engineers are great at analyzing things and spreadsheets and everything. He was very familiar with the company that he wanted to approach about acquiring him.
They had expressed interest in the past, and he was getting ready to approach them. And he had done this spreadsheet that laid out all the different ways this bigger company could acquire him, since he was kind of small, and improve operations: put in better systems, upgrade this, upgrade that. And that's how he had come up with the value that this company would pay him for his company. Sure. And I'm like, you know, you've basically done their spreadsheet where they determine their rate of return.
They're not determining how much they're going to pay you. What they're going to pay you for is your real operations right now. So by doing this process that you've been discussing early on, that's how you grow. That's where you get to benefit from the hidden value in your company, rather than someone not paying you for it and then realizing the value of it. Right on, Walter.
Demonstrated performance pays much higher than projected performance, no question about it. In fact, I was just in a board meeting with a client the other day who's preparing for an exit, and their belief is they need to demonstrate six months of their elevated performance before they'll get, let's just say, full credit for it. Not even a whole year, just doing it for six months. But that six months is dramatically more valuable than a spreadsheet that says if you just do these things, you'll be fine. Because we all know that as good as a plan may be, until you see it actually working, you've got to discount it.
Yeah. Well, then if it's hidden and you can find it, and then you can accelerate it, that's even better. That's even more better. I love that. And you highlighted something earlier, Pat, that a lot of what we're looking at is process work, process changes.
And the beautiful thing about process changes is that they can be identified, then designed and put in place in weeks, not years or quarters. If you implement a new ERP system, it's going to be a year and a half until you start seeing benefit. We think of it this way: there's actual capacity and accessible capacity. The accessible capacity is that which, based on the way you're running the business, your current processes and systems, you're actually able to use. And I'll give you a story.
This is from during COVID. There's a company that's a contract manufacturer of nutraceuticals. So they would fill small vials and pills of supplements and things like that that were being sold to the public. And they were growing hand over fist. They were actually already owned by a private equity firm.
And they had grown so fast, so quickly, so much, that they were in a good spot where they could exit. And then the management team came to them and said, "We need a new plant. We've grown so fast, so much, we're out of capacity." And the private equity firm's like, "Well, if we put in a new plant, we've got to hold this for two more years to get it done and then show that it worked and everything's smooth." So, they decided to put it on the market instead.
Very understandable, not uncommon. And our client was one of the prospective buyers, and they had us do an operational diligence, and when we came back we were able to share with them that they were at maybe 40% of capacity. Wow. Yes. When they calculated or thought about capacity, it was relative to where they were.
They're like, "We're already running seven days a week. We're running out of space. We're running out of machine hours." And what we saw when we went through and looked at uptime, line speed, quality issues, whether they were making product they were selling immediately or product they were going to sell three months down the road, was that you could literally double sales without adding equipment, with a fraction of the people. Because this isn't about working more machine hours. It was about improving the speed, the effectiveness, and how many hours a day they're actually able to run, the uptime.
And in fact, we do a summit where we get business owners and private equity firms together. That client was at one of them last year and was able to report that, yep, in fact, they've been continuing the growth and did not have to add equipment or people, and they're now getting ready for an exit. Wow. That's a great story. All right, I'm going to shift gears a little bit to a question, and this will maybe be the last question, that everyone's interested in on this topic at this point.
With AI becoming more and more prevalent every 30 seconds, has operational due diligence changed? Are buyers starting to, of course they are, evaluate technology, automation, and data differently now than they did even six months ago, let alone a few years ago? I will share this, and I think this is something you'll find in almost any area: AI isn't going to replace you or replace a function that's really critical today, but it can support someone who is doing that work, whether you're in marketing or, in our case, evaluating operations. We use AI and it is helping us. We can do a lot more.
We can do it faster. We can look at populations of data, not samples of data. It helps us see patterns. One of the things it helps us do: if we send in a consultant to tour a facility, they have their own particular expertise. But now, with the ability to use AI to look at the data and look at our interviews, instead of sending in a team of two, three, or four consultants, we could send in the one, and we're able to digest that data and develop our complete set of observations and recommendations.
So it is having an impact. And what it's doing is it's going to become easier and easier for a buyer to evaluate an operation with less of an invasion. A lot of times diligence gets heavy when you're doing a financial diligence and a QoE, and then legal, environmental, commercial, and people are getting exhausted from it. Now, using the same tour and gathering the right data, you can complete an operational diligence without becoming a burden to the sellers. Okay.
So, as we wrap up, last question, because you know the drill, you've been with us before. If we can give owners who are listening today one, two, or three steps that they should be thinking about now, no matter where they're at in their journey, what steps would you tell them in regard to operational due diligence? Thank you, this is really fun. So the first one is, look at variation. Look at the difference between your best day and your worst day, in terms of, you name it.
It could be in terms of production, shipments, quality, what have you. It could also be done in terms of sales cycles and forecast accuracy. Look at what's the high-water mark for what we've demonstrated on any given day, any given shift, any given facility or month, and then what would happen to your performance if every day were like that. That's the first thing that we can look for. There are many times where we can go well beyond the best demonstrated day.
But if we can do it on this day, or in this shift, or this operation, we can do it every day. It just helps you to directionally understand how much potential there is. Using another great metaphor, it's like farmland. You've got a farm, and then one day you're out shooting for some food, if you remember the TV show I'm thinking of, and you find out there's oil under that farmland. Yeah, if you're Jed Clampett.
Yes, if you're Jed Clampett. Or Jethro. Yeah, Elly May. Granny. It's sort of like the surveying that they do to figure out if there's oil on land. That's what you're doing with your own operation.
There's that hidden value down in the ground that you're looking for. It's exactly right. It's not going to tell you how to get it. It's just going to help you understand that it's there. And even if it was 10, 20, 30% more, that has a dramatic impact on your profitability, and by the way, your lifestyle, like we were talking about earlier, because to get there you can't be involved as the owner in a lot of it.
Yeah, drives that multiple up. It sure does. Okay, so Tim, tell folks how they can contact you if they want to talk to you about operational due diligence. Yes, there are a couple of very quick ways. One, go to The ProAction Group website, www.proactiongroup.com.
I'm also on LinkedIn, very easy to find. And thank you for bringing up the book Shocking Profit. It's available on Amazon and at shockingprofit.com. Excellent. Very good. Always fun to have you with us.
Great conversation, per usual. Thanks for joining us. And listeners, if you need help building that valuable, transferable, sellable business, or getting your business ready or getting you personally ready for that eventual exit, which is 100% sure to happen, it's just a matter of when and how, contact us at ENNIS Legacy Partners at email@ennislp.com. And if you'd prefer to get started on your own, just getting educated and maybe even doing some work on your own, go to exitreadiness.com. We've created a DIY platform, ExitReadiness® DIY™.
There are a ton of resources there, and there's a free version and a couple of subscription versions. You could get started there if you want to. Thanks for listening. If you found today's conversation helpful, please consider liking it, sharing it, and then subscribing. We'd appreciate that. Until next time on the ExitReadiness® PODCAST, this is Pat Ennis and Walter Deyhle signing off.
