How is Operational Due diligence Performed in a Business Acquisition? A Guide for Indian Businesses

You’ve found the perfect business to acquire. The financials look solid, and the growth potential seems immense. But what about the day-to-day reality? A successful acquisition goes beyond the balance sheet. While financial and legal checks are common, a thorough operational due diligence is what separates a successful integration from a costly failure. This crucial investigation uncovers how a business truly functions, revealing its strengths, weaknesses, and hidden risks.

This guide will walk you through the business acquisition due diligence process India, tailored for the unique challenges and opportunities in the Indian market. Understanding the operational due diligence importance in acquisitions is the first step towards making an investment that pays off, not one that brings unexpected and expensive surprises.

Understanding the ‘Why’: The Core of Operational Due Diligence

Before diving into the “how,” it’s essential to understand what operational due diligence is and why it’s a non-negotiable step for any serious buyer. This process provides a real-world view of the business, moving beyond the numbers to assess the machinery that makes the company run.

What is Operational Due Diligence?

Operational due diligence is an investigative process to verify the functional and operational aspects of a target business. It examines everything from the company’s internal processes and technology systems to its human resources and supply chain relationships.

Think of it this way:

Financial Due Diligence: Checks the numbers—balance sheets, profit and loss statements, and cash flow.
Legal Due Diligence: Reviews contracts, licenses, and compliance to ensure there are no hidden legal liabilities.
Operational Due Diligence: Assesses how the business generates those numbers and whether its operations are efficient, scalable, and sustainable.

To use an analogy, if financial due diligence is checking the engine’s specs on paper, operational due diligence is taking the car for a thorough test drive to see how it really performs on different terrains, checking for strange noises, and making sure it can handle the journey ahead.

Why is it Critical for Businesses in India?

Performing operational due diligence for businesses India presents a unique set of considerations. The Indian business landscape is characterized by diverse labour laws, complex multi-state supply chains, and a business culture where personal relationships can be as crucial as formal contracts. A deep operational review is vital for several reasons:

Identifying Hidden Risks: It can uncover issues like an over-reliance on a single key supplier, a high dependency on the owner for daily operations, or outdated technology that will require significant investment.
Validating Growth Assumptions: The seller might project a 50% growth in production. Operational due diligence verifies if the existing machinery, staff, and supply chain can actually support that growth or if it’s just a hopeful number.
Creating a Realistic Integration Plan: Understanding the target company’s culture, IT systems, and processes is crucial for planning a smooth post-acquisition merger. A clash of cultures or incompatible systems can derail an otherwise promising acquisition.
Uncovering Undisclosed Liabilities: It can reveal non-compliance with labour laws (like PF or ESI contributions), environmental norms, or necessary operational licenses, which could result in future penalties and legal trouble.

The 5 Key Steps in Operational Due Diligence in India

The business acquisition due diligence process in India can be broken down into five core areas of investigation. A systematic approach ensures that no stone is left unturned, providing you with a complete picture of the business you intend to buy. These are the key steps in operational due diligence India.

Step 1: Human Resources & Organisational Structure

A business is only as good as its people. This step evaluates the human capital and organisational health of the company.

Management Team: Assess the skills, experience, and stability of the key management personnel. A critical question to ask is: how dependent is the business on the current owner or a specific manager? If they leave after the acquisition, will critical knowledge or client relationships walk out the door with them?
Employees: A detailed review of the workforce is essential. This includes examining employee contracts, salary and wage structures, and historical attrition rates. Crucially, you must verify compliance with India’s intricate labour laws, including Provident Fund (PF), Employees’ State Insurance (ESI), and gratuity obligations. Any past or pending labour disputes must be thoroughly investigated.
Culture: Analyse the company culture. Is it a top-down, hierarchical organisation or a collaborative, flat structure? Understanding this helps predict how well it will integrate with your own company culture, preventing post-merger friction and a drop in morale.

Step 2: Information Technology (IT) & Systems

In today’s digital world, a company’s IT infrastructure is its central nervous system. A failure here can paralyze the entire operation.

Infrastructure: Evaluate the condition and capacity of the company’s hardware (servers, computers) and software. Pay special attention to any custom-built software, as it can be difficult and expensive to maintain without the original developers. Determine if the current systems are scalable enough to support your future growth plans or if they are outdated and will require immediate replacement.
Licenses & Compliance: Verify that all software licenses are genuine and up-to-date. Using pirated software can lead to severe legal and financial penalties. Additionally, check if their accounting and billing systems are fully compliant with GST regulations and if their data handling practices align with India’s data privacy laws.
Data Management: Assess the company’s data management practices. How is customer, sales, and operational data collected, stored, and protected? Is there a reliable backup and disaster recovery plan in place? Access to clean, well-organised data is critical for making informed business decisions post-acquisition.

Step 3: Production, Supply Chain, and Vendor Management

This step examines the core engine of the business—how it produces its goods or delivers its services.

Processes: Map the end-to-end production or service delivery workflow. This helps identify inefficiencies, bottlenecks, and areas for potential cost savings. Review quality control procedures to understand the rate of defects or customer complaints.
Suppliers: Analyse contracts with key suppliers. Understand the pricing, credit terms, and contract duration. The most critical part is to assess supplier concentration risk. If the business relies on a single supplier for a critical raw material, any disruption in that relationship could halt production entirely.
Inventory: Review the company’s inventory management system. Analyse stock levels, turnover rates, and methods for valuing inventory. Look for signs of obsolete or slow-moving stock, as this can tie up working capital and represent a hidden loss.

Step 4: Sales, Marketing, and Customer Base

A strong customer base is the lifeblood of any business. This step validates the company’s revenue streams and market position.

Customer Analysis: Identify the company’s top customers and analyze the revenue generated from each. High customer concentration is a significant risk. For instance, if a single client accounts for over 20% of total revenue, losing that client could be devastating for the business. Also, review customer satisfaction levels and churn rates.
Sales Process: Understand the sales pipeline, from lead generation to conversion. Evaluate the effectiveness of the sales and marketing teams and the channels they use. Are sales driven by a repeatable process or the personal relationships of one or two salespeople?
Contracts: Scrutinize key customer contracts. Look for unusual terms, long-term pricing commitments that may become unprofitable, or clauses that could create future liabilities. Check renewal rates and dates to forecast future revenue streams accurately.

Step 5: Legal & Regulatory Compliance

This step ensures the business is operating within the bounds of the law, protecting you from inheriting fines and legal battles.

Licenses & Permits: Verify that all essential operational licenses and permits are valid and current. This includes central, state, and local licenses such as those required under the Shop and Establishment Act, FSSAI for food businesses, and specific trade licenses from the local municipal corporation. For example, a business in Bengaluru would need approvals from the BBMP website.
Environmental & Safety: Check for compliance with all relevant environmental regulations and workplace health and safety standards. Non-compliance can lead to hefty penalties, operational shutdowns, and reputational damage.
Intellectual Property (IP): Identify all IP assets used in the business—such as trademarks, brand names, patents, and proprietary software. Verify that the company legally owns or has the right to use this IP. This is crucial for technology and consumer brand companies.

Your Business Acquisitions Operational Due Diligence Guide: A Practical Checklist

To help you get started, here is a simplified checklist. While this business acquisitions operational due diligence guide is not exhaustive, it covers the critical questions you should be asking.

HR & Management Checklist

[_] Who are the key employees, and what are their roles and responsibilities?
[_] What has been the employee turnover rate for the past 2 years?
[_] Are all Provident Fund (PF) and ESI contributions fully paid and up to date?
[_] Are there any pending or past employee lawsuits or disputes?
[_] Has an organisational chart been provided?

IT & Systems Checklist

[_] Can you provide a list of all critical software and their license expiry dates?
[_] Is there a formal IT security policy and a disaster recovery plan?
[_] How old is the primary hardware (e.g., servers)?
[_] Is the company’s website and e-commerce platform stable and secure?

Operations & Supply Chain Checklist

[_] Who are the top 5 suppliers, and what are their contract terms?
[_] Is there a dependency on any single supplier for more than 25% of raw materials?
[_] What is the current production capacity versus its actual utilization?
[_] Can you review the quality control reports for the last 12 months?

Customers & Sales Checklist

[_] What percentage of total revenue comes from the top 10 customers?
[_] What is the average customer acquisition cost (CAC) and customer lifetime value (LTV)?
[_] What does the sales pipeline for the next 6 months look like?
[_] Are there any major customer contracts up for renewal soon?

Conclusion

A successful business acquisition is built on a foundation of thorough investigation. While the numbers on a financial statement tell part of the story, operational due diligence reveals the plot, the characters, and the potential twists. It is an essential, non-negotiable step that provides a true picture of a business’s health, its hidden risks, and its genuine potential. This process isn’t just about finding flaws to negotiate a lower price; it’s about deeply understanding the asset you are buying to ensure a smooth transition, unlock synergies, and achieve long-term success.

The business acquisition due diligence process in India requires deep expertise across multiple domains—from labour law to supply chain logistics. Don’t leave your investment to chance. Contact TaxRobo’s M&A advisory team today for a comprehensive due diligence report that protects your interests.

Frequently Asked Questions (FAQs)

Q1: What is the difference between operational and financial due diligence?

A: Financial due diligence focuses on verifying financial records—like balance sheets and profit/loss statements—to confirm the company’s financial health and accuracy of its reporting. In contrast, operational due diligence examines how the company achieves those numbers—its processes, people, technology, supply chain, and customer relationships—to assess its efficiency and sustainability.

Q2: How long does the operational due diligence process take in India?

A: The timeline varies significantly based on the size and complexity of the target company. For a small to medium-sized business in India, a comprehensive operational due diligence process can typically take anywhere from 2 to 6 weeks to complete.

Q3: What is the biggest red flag in operational due diligence for businesses in India?

A: One of the biggest red flags is a heavy dependence on the owner for all key operations, supplier negotiations, and customer relationships. This “key person risk” means the business’s value could plummet after the owner departs. Another major red flag is significant non-compliance with statutory requirements like PF, ESI, or GST, which can expose the acquirer to hefty future liabilities and legal complications.

Q4: Can I conduct operational due diligence myself?

A: While a business owner can perform preliminary checks and ask initial questions, it is highly recommended to engage professionals like legal and financial advisors. Experts bring an objective, unbiased perspective and have the experience to identify subtle risks and complex issues that an untrained eye might miss. Professional involvement makes the investment significantly safer and provides a stronger basis for negotiation.

Operational Due Diligence: A Business Acquisition Guide