Enhancing Investment Outcomes Through Operational Due Diligence in Private Equity

Private equity investors spend months analyzing financial statements, market positioning, and valuation models before closing a deal. Yet, many portfolio companies still underperform—not because of financial miscalculations, but due to operational failures. A business can look strong on paper, but hidden inefficiencies, leadership gaps, or execution bottlenecks can quickly erode value. This is where operational due diligence (ODD) becomes indispensable.

For years, financial due diligence dominated deal-making, with investors primarily focused on revenue streams, EBITDA multiples, and debt structures. But financial statements alone don’t reveal whether a company can scale efficiently, manage costs, or execute growth strategies. A 2023 Bain & Company study found that 65% of private equity firms reported missing growth targets due to operational weaknesses rather than financial miscalculations, underscoring why ODD is now a non-negotiable part of the investment process.

ODD extends past risk assessment to reveal untapped value. A company with streamlined operations, strong leadership, and scalable processes can justify a higher valuation, while one riddled with inefficiencies may require a lower purchase price or extensive post-deal restructuring. For private equity professionals, understanding how to assess operational risks before closing a deal is a prerequisite to maximizing returns and minimizing post-acquisition surprises.

Let’s break down how ODD influences investment decisions, from evaluating management teams to spotting operational red flags and optimizing post-acquisition performance.

Operational Due Diligence in Private Equity: Why It’s a Non-Negotiable

Investors can analyze financial statements down to the last decimal, but if they don’t assess how a company operates in reality, they’re taking unnecessary risks. Operational failures, not financial miscalculations, are among the top reasons private equity investments underperform.

Investors who don’t conduct deep operational due diligence (ODD) before closing a deal risk running into:

• Unscalable business models – Companies that look profitable at a small scale but collapse under rapid growth.
• Hidden inefficiencies – High-margin businesses on paper that actually bleed cash due to weak cost controls.
• Leadership failures – Founders or executives who lack the ability to navigate expansion, manage teams, or execute a turnaround.
• Supply chain disruptions – Dependency on fragile logistics networks, single-source suppliers, or outdated procurement strategies.
• Regulatory blind spots – Compliance gaps that lead to fines, legal action, or even shutdowns post-acquisition.

Consider private equity firm TPG Capital, which invested in J. Crew before its bankruptcy. While financial due diligence supported the investment, operational cracks in supply chain logistics and brand positioning were overlooked, ultimately leading to performance decline and restructuring. A more rigorous ODD process could have flagged these weaknesses before the deal was made.

Leading private equity firms—Blackstone, KKR, and Carlyle Group—have built dedicated ODD teams to scrutinize operational efficiency before closing deals. Blackstone, for example, integrates supply chain analysis, IT infrastructure reviews, and executive performance assessments into its due diligence process, allowing it to identify weak points that require pre-close intervention.

Skipping ODD is no longer an option for firms serious about protecting investment returns and avoiding post-deal surprises. Investors that fail to assess operational risks often end up spending the first year fixing problems they should have uncovered before acquisition.

Evaluating Management Teams and Internal Processes: The People Factor in Due Diligence

A company’s financials might check all the right boxes, but without strong leadership and efficient internal processes, even the best investment can fail to deliver returns. Private equity firms recognize that a company’s ability to execute its strategy, scale operations, and adapt to market shifts hinges on its leadership team and internal decision-making structures.

The first step in gauging leadership capability is evaluating how executives operate under pressure. A leadership team may have impressive credentials, but can they navigate rapid growth, economic downturns, or operational disruptions? Investors look at a CEO’s track record in executing strategic pivots, the CFO’s ability to manage capital allocation, and whether senior executives align with investor goals rather than personal incentives.

Picture an investment case where a company has strong financials but high employee turnover and internal dysfunction. While spreadsheets won’t reveal these issues, due diligence interviews, cultural assessments, and direct interactions with management often do. If key executives hesitate when questioned about scalability challenges, competitive threats, or margin compression, it’s a red flag. Apollo Global Management and TPG Capital, for instance, have built reputations for restructuring leadership teams post-acquisition, ensuring portfolio companies have experienced executives who can drive operational efficiency rather than simply maintaining status quo.

Aside from leadership, internal processes must be structured for efficiency. Companies often appear operationally sound at first glance, but deeper analysis may reveal bottlenecks in decision-making, bureaucratic inefficiencies, or outdated technology stacks that hinder growth. Investors evaluate whether operational workflows are streamlined or weighed down by inefficiencies, whether decision-making is centralized or decentralized, and whether a company’s systems and reporting structures support real-time data-driven decision-making.

Compliance and risk management are also core elements of ODD. A company may have strong revenue growth, but if it’s operating with undisclosed regulatory risks, weak internal controls, or compliance gaps, the investment may carry more liability than upside. Investors must determine whether these inefficiencies are fixable post-deal or point to deeper structural weaknesses that could erode returns.

Financial and Operational Red Flags: Identifying Deal Breakers Before Closing

Private equity firms don’t just look for growth potential—they look for hidden risks that could derail an investment. While operational due diligence helps uncover scalability and leadership gaps, investors must also scrutinize financial inconsistencies, operational inefficiencies, and regulatory vulnerabilities before finalizing a deal. A company that projects an image of stability may, in reality, suffer from hidden cost inefficiencies, erratic income trends, or breakdowns in oversight and accountability—all of which can chip away at investment gains.

Common red flags investors watch for include:

• Revenue inconsistencies – If revenue is growing, but margins are shrinking, where is the value leakage? Are customer acquisition costs rising unsustainably?
• Cash flow instability – Strong EBITDA figures mean little if working capital cycles are strained, leading to liquidity problems.
• Uncontrolled operating expenses – A company may appear profitable but be overly reliant on aggressive cost-cutting rather than sustainable margin improvements.
• Overreliance on key customers or suppliers – If more than 30% of revenue comes from one customer, losing that contract could create significant financial instability.
• Unresolved compliance or legal issues – Regulatory penalties, pending lawsuits, or questionable accounting practices can become post-acquisition liabilities.

The failure to recognize supply chain weaknesses, misaligned cost structures, and flawed revenue forecasting turned what was supposed to be a profitable investment into one of the most high-profile private equity missteps in recent years.

In addition to financial warnings, operational inefficiencies are equally telling. Investors look at manufacturing processes, service delivery, and workforce productivity to determine if a company is operating at peak efficiency. If a business is overly reliant on manual processes rather than automation, or has slow order fulfillment due to fragmented logistics, it’s a sign that achieving scale will require significant capital investment post-acquisition.

Private equity firms with strong due diligence practices avoid companies with poorly structured financials and operational weaknesses that could lead to costly turnarounds. A 2022 survey by McKinsey found that 58% of private equity firms that experienced underperformance in portfolio companies traced it back to due diligence oversights, proving that ignoring financial and operational red flags can directly impact investor returns.

Optimizing Post-Acquisition Performance: Turning Due Diligence Insights into Action

Operational due diligence goes beyond filtering out weak investments—it lays the groundwork for unlocking full investment potential. Once an acquisition is complete, the insights gathered during due diligence serve as the foundation for value creation strategies, guiding investors on where to focus first.

Private equity firms that proactively act on operational findings don’t get bogged down in fixing unexpected problems during the first year, instead, they move quickly to implement efficiency improvements, margin expansion strategies, and revenue growth initiatives. A company that showed supply chain inefficiencies in due diligence might need contract renegotiations, logistics optimization, or sourcing diversification. If leadership weaknesses were flagged, investors may need to bring in experienced executives or adjust incentive structures to align management with shareholder interests.

Beyond fixing inefficiencies, operational due diligence provides a roadmap for strategic upgrades. Companies with outdated systems or fragmented processes often see immediate improvements by implementing digital transformation strategies, such as ERP integrations, AI-driven analytics, and automation. Similarly, pricing models and cost structures that seemed inefficient during due diligence can be recalibrated to improve margins without sacrificing market position.

Private equity firms that treat due diligence as an investment roadmap—not just a risk assessment—set themselves up for long-term success. Rather than reacting to post-deal inefficiencies, they take targeted, proactive steps to optimize operations, improve leadership effectiveness, and unlock scalability that drives higher investor returns.

Operational due diligence has shifted from being a secondary consideration to a fundamental pillar of successful private equity investing. While financial due diligence confirms historical performance, it fails to capture the scalability, leadership effectiveness, and operational risks that can determine a company’s future trajectory. Investors who neglect ODD often find themselves tied up in post-acquisition fixes, dealing with inefficiencies, cost overruns, and governance issues that could have been identified earlier.

By thoroughly assessing management strength, internal processes, supply chain resilience, and financial sustainability, private equity firms not only mitigate risk but also identify pathways for operational improvements and value creation. Companies with structural inefficiencies, weak leadership, or overleveraged cost bases may demand extensive restructuring, while those with scalable processes, resilient business models, and well-aligned leadership teams present clear opportunities for growth. The most successful private equity firms use operational due diligence not just as a defensive measure, but as a strategic tool—leveraging their findings to optimize performance, streamline operations, and maximize investment returns. In a market where every competitive edge matters, ODD isn’t just about avoiding bad deals—it’s about positioning investments for long-term success.