Operational Due Diligence Checklist for Small Business Acquisitions

The Phantom Profit Trap: A Broker’s Tale

Let’s talk about Marcus. Marcus is a broker who thought he had the "perfect" listing. It was a specialized manufacturing firm with $2M in EBITDA, steady year-over-year growth, and a clean balance sheet. The Financial Due Diligence (DD) was a breeze. The Quality of Earnings (QoE) report came back spotless. The buyer, a private equity group with plenty of "dry powder," was ready to wire the funds.

Then came the operational walkthrough.

It turned out the "proprietary inventory system" was actually just the warehouse manager, Bob, who memorized where everything was. The "state-of-the-art" machinery? It hadn't seen a service technician in five years because the owner didn't believe in "wasting money" on preventive maintenance. The financials said this business was a goldmine; the operations said it was a ticking time bomb.

Marcus saved the deal, but only by pivoting hard. He renegotiated the purchase price to account for $500k in immediate CapEx needs and structured an earn-out to keep Bob (and his brain) onboard.

The Lesson: Financials tell you what the business did yesterday. Operational Due Diligence tells you if it can do it again tomorrow.

Why Operational Due Diligence Matters

According to the Harvard Business Review, between 70% and 90% of M&A deals fail to meet their investment thesis. While financial surprises are common, the real deal-killers are often operational: key person dependency, crumbling infrastructure, or supply chains held together by a handshake.

Operational due diligence examines how the business actually runs day-to-day. It identifies operational risks, transition challenges, and opportunities for improvement.

Operations Overview

Daily Operations Assessment

The first step is to verify that the business is a system, not just a job for the owner. If the owner gets hit by a bus (or just wants to go to Hawaii for a month), does the revenue stop?

Area	Questions to Answer
Hours	What are the true operating hours (including after-hours support)?
Workflow	How does a lead become a sale, and a sale become a delivered product?
Customer interaction	Who actually talks to the clients? (Is it just the owner?)
Quality control	How is quality maintained and measured?
Management	Who makes daily decisions without calling the owner?

Process Documentation

A business running on "tribal knowledge" is impossible to scale and risky to buy.

• Standard Operating Procedures (SOPs): Do they exist, or is it all oral tradition?
• Process Currency: Are the documented processes actually what happens on the floor?
• Training Materials: Can a new hire be up to speed in 30 days using these materials?
• Checklists and Forms: Are these actively used for quality assurance?
• Knowledge Transfer: Is the "secret sauce" documented, or is it stuck in the owner's head?

Broker Note: Watch out for "Key Person Risk." If the business can't survive a 3-month owner vacation, you aren't selling a business; you're selling a high-paid job. Buyers will discount heavily for this.

Equipment and Assets

The "Deferred Maintenance" Trap

This is where EBITDA adjustments often get messy. Sellers love to "add back" maintenance costs to show higher profits. But as a buyer, you need to know if that extra profit is just a future expense in disguise.

Research from Pacific Partners Consulting Group suggests that every $1 deferred in maintenance costs $4 in future capital renewal.

Equipment Assessment

Equipment	Evaluation Areas
Age	Years in service vs. industry standard life expectancy.
Condition	Working order vs. "held together with duct tape."
Remaining life	How soon until a major CapEx event is required?
Replacement cost	accurate current market replacement cost.
Maintenance records	Proof of regular service (preventive vs. reactive).

Equipment Checklist

• Complete asset list with serial numbers
• Age and condition of each major item
• Maintenance logs (look for gaps)
• Warranties still in effect
• Immediate replacement needs identified (Post-Close CapEx)
• Capital requirements estimated for next 3-5 years

Technology Systems

Don't overlook "Technical Debt." If their "CRM" is a rolodex or an Excel sheet from 1998, the buyer faces a massive integration cost.

System	Review Areas
Accounting software	Version, capability, and cloud-integration readiness.
CRM/customer database	Data hygiene and ownership of customer records.
Operational software	Industry-specific ERPs or custom-built (and unsupportable) tools.
Website/e-commerce	Platform stability, SEO ownership, and mobile responsiveness.
Phone/communication	VoIP contracts and hardware age.

Facilities

Physical Inspection

Never trust the photos. Walk the floor. Look at the ceiling tiles (leaks?), check the loading docks, and inspect the employee break rooms.

• Facility condition (interior/exterior)
• Adequate space for current operations + 20% growth
• Layout efficiency (Is product moving in circles?)
• Safety compliance (OSHA violations are deal killers)
• Accessibility requirements (ADA compliance)
• Parking adequacy for staff and customers
• Storage capacity
• Expansion capability (Right of First Refusal on adjacent units?)

Facility Issues

Issue	Impact
Deferred maintenance	Direct deduction from purchase price or Working Capital.
Code violations	Compliance cost + potential fines/shutdowns.
Space limitations	Growth constraints that cap future revenue.
Location problems	Accessibility issues that drive customers to competitors.

Supplier and Vendor Review

Key Supplier Analysis

If 80% of their raw material comes from one factory in a geopolitically unstable region, you have a problem.

Supplier Category	Review Points
Primary suppliers	Relationship strength. Is pricing tied to the owner personally?
Critical vendors	Dependency risk. What happens if they go out of business?
Service providers	Contract terms (Are they transferable/assignable?)
Utilities	Rates, contracts, and transfer requirements.

Supply Chain Considerations

• Identify all critical suppliers (Pareto principle: who provides the top 80%?)
• Assess supplier concentration (Single-source risks)
• Review contractual terms (Change of Control clauses)
• Evaluate switching costs (How hard is it to fire them?)
• Identify alternatives (Is there a backup plan?)

Customer Operations

Customer Service Model

• Acquisition: Is it repeatable marketing, or just the owner's golf buddies?
• Service: Is the service level agreement (SLA) sustainable without the owner working 60 hours/week?
• Experience: What do the Google/Yelp reviews actually say?
• Retention: Is there a formal process for saving at-risk accounts?

Customer Concentration

The "Gorilla Client" is a classic deal structure issue. If Customer A leaves, does the business tank?

Customer	% Revenue	Relationship Length	Risk Level
Customer A	__%	__ years	High/Med/Low
Customer B	__%	__ years	High/Med/Low
Customer C	__%	__ years	High/Med/Low

Inventory (if applicable)

Inventory Review

Dead stock is not an asset; it's a liability that takes up rent.

• Physical inventory count (Third-party audit recommended)
• Inventory valuation method (FIFO/LIFO - does it match tax returns?)
• Turnover rates (Compare to industry averages)
• Obsolete inventory identification (The "dusty box" test)
• Reorder processes (Automated vs. gut-feel)
• Storage conditions (Temperature/humidity control)

Inventory Issues

Issue	Impact
Slow-moving inventory	Valuation adjustment (often pennies on the dollar).
Obsolete stock	Immediate write-off needed before close.
Inadequate tracking	Operational risk (theft/shrinkage).
Poor storage	Loss/damage risk and insurance issues.

Human Resources Operations

Team Assessment

People are often the most valuable—and volatile—asset.

Role	Key Questions
Key employees	Who holds the relationships/knowledge? (Golden handcuffs needed?)
Tenure	How long employed? (High turnover = culture flags)
Succession	Is there a "Bus Factor" backup for each role?
Training	How are skills maintained?
Morale	Team satisfaction (Glassdoor reviews, unofficial chats).

HR Processes

• Hiring process (Is it scalable?)
• Training procedures (Onboarding documentation)
• Performance management (Are reviews happening?)
• Payroll processing (Compliance with overtime laws?)
• Benefits administration (Transferability of plans)

Operational Red Flags

If you see these, pause the deal and dig deeper.

Red Flag	Concern
Owner does everything	Transition risk: The business is an extension of their ego.
No documented processes	Knowledge loss: When the owner leaves, the brain leaves.
Old/failing equipment	Capital needs: The "cheap" purchase price is actually expensive.
Key employee leaving	Capability loss: Did the top sales rep just quit?
Single-source suppliers	Supply risk: One fire at a vendor's plant stops your business.
Customer complaints increasing	Service issues: The brand is eroding before you buy it.

Next Steps for Brokers

Operational diligence isn't about killing deals; it's about structuring them correctly. If you find deferred maintenance, shift the conversation to CapEx adjustments. If you find key person risk, talk about transition service agreements (TSAs) or earn-outs.