Operational diligence isn't on anyone's checklist. How are you doing it? - Searchfunder

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by an investor from University of Virginia
in Tampa, FL, USA

3h ago

Operational diligence isn't on anyone's checklist. How are you doing it?

@redacted‌ and I compared notes today on the deals we've each reviewed under LOI this past year, and the pattern that keeps showing up is that everyone does financial diligence and almost nobody does operational diligence. One story that stuck with me: A buyer closes on a solid business. Two months in, the seller picks a fight with the front desk guy making $25/hour, and he quits on the spot. He wasn't on anyone's key person list. That departure cost the buyer $400K to the bottom line over the next twelve months, because the ops manager had to leave the shop to cover the front, productivity cratered, and inventory controls went out the window. No QofE would have caught that. The only way you catch it is time with the seller. Dozens of hours, ideally in person. Standing weekly calls. Ride-alongs. Tracing how the business moves cash to the bank and learning who actually touches each step. Curious how folks here have handled this, especially getting access. Sellers push back on time, and the people who really know where the skeletons lie are usually off-limits pre-close. What's worked for you?

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reply by an investor 2h ago
from University of Virginia in Tampa, FL, USA

The PE comparison is a correct frame, and actually explains the gap. PE firms have dedicated teams / budgets for operational DD, whereas a SF searcher has neither. The work falls entirely on the buyer. The good news though is a searcher has an advantage over PE. Direct, repeated access to the seller. One of the better deals I walked away from looked great on paper. Almost $1M SDE + low multiple. I couldn't figure out why until I did a ride along and watched the seller's phone blow up all day from customer, vendors, and employees. Every business relationship ran through him. No document request list surfaces that ^ but a day shadowing sure did.

reply by a searcher 1h ago
from Oregon State University in San Francisco, CA, USA

Thank you for writing about this — this gap shows up for almost everyone I talk to who's looking to buy a business. There's no clean solution. I've done everything from being an undercover customer, to taking entry-level jobs at similar businesses, to running diligence on multiple deals in the same industry simultaneously just to fill the gaps. If you can spend six months learning an industry in depth — informational interviews across multiple levels of employees, plus conversations with other owners — you'll close those gaps much faster. If you want to move quickly instead, do a risk-appropriate acquisition: buy something small as a stepping stone into the bigger deal you actually want in that vertical. Take on less debt, hold more cash, or underwrite to a lower return than your model shows. You can also find someone else trying to buy in the same sector and make the diligence process efficient, possibly look at a partnership. Fine a mentor, investor, or build a board of advisor from people in the industry. I've bought very small businesses purely to learn an industry, and it's worked well — small businesses tend to carry great margins, and since the multiples are so low, I've always made my money back quickly. It's been one of the fastest ways I've found to actually learn. It gets harder to do this as you get older, have kids, or climb the ladder in other careers. It often feels like you have to start at the bottom again, but starting at the fundamentals is the best way to do it, (yes its painful). Small business owners have to take on alot more responsibilities and are forced to wear multiple hats, you have no way out of it.

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