PE teams conduct on-site facility assessments to verify that the operational narrative matches reality. What they're looking for: evidence that operational problems exist beyond what financial statements reveal.
A thorough facility tour generates a checklist of observations. Most are positive indicators. Some are red flags—minor issues that, when combined, signal broader operational problems.
What Red Flags Actually Indicate
A single red flag doesn't kill a deal. A pattern of red flags suggests systemic operational challenges that will consume post-close management attention and capital.
Red flags fall into categories:
Maintenance & Equipment:
- Visible corrosion on stainless steel equipment (deferred cleaning/maintenance)
- Outdated control systems (no monitoring, no real-time adjustment)
- Leaking pumps, valves, or connections (preventive maintenance gaps)
- Equipment in production that should be retired (efficiency loss)
- No documented preventive maintenance schedule
- No facility engineering documentation
Process & Operations:
- Excessive downtime during shift changes (process hand-off failures)
- Manual adjustments to equipment setpoints throughout the day (process drift)
- Multiple staff working around equipment problems in real-time (reactive culture)
- Inconsistent product changeover times (unstable processes)
- High rework stations or inspection hold areas (quality issues)
Safety & Compliance:
- OSHA notices or citations posted visibly (recent violations)
- Inadequate PPE compliance (safety culture gaps)
- Unclear or missing lockout/tagout procedures (LOTO risks)
- Inadequate documentation of food safety protocols (compliance risk)
- Staff unable to articulate standard operating procedures clearly
Organization & Culture:
- High staff turnover signals on bulletin boards (retention issues)
- Poor plant cleanliness in non-critical areas (discipline gaps)
- Management unable to answer basic operational questions accurately
- Inconsistent shift-to-shift execution visible in production logs
- Lack of visible data dashboards or performance metrics
What Red Flags Mean for Valuation
A facility with multiple red flags typically shows lower OEE, higher labor costs, and greater downtime than peers. These operational gaps translate to lower sustainable EBITDA.
If a facility shows $5M EBITDA with 15 red flags visible during due diligence, the question becomes: Is this EBITDA achievable with inherited operational issues? Or will operational challenges reduce EBITDA in Year 1?
The Due Diligence Approach
Spend time on the production floor. Ask operators about changeover procedures. Request preventive maintenance schedules. Review recent downtime logs. Observe shift handoffs. These 90 minutes of observation reveal more than 10 hours of financial analysis.
Document red flags and categorize by severity. Minor flags (outdated signage) are cosmetic. Major flags (no documented safety procedures) indicate risk. Patterns of flags (multiple maintenance gaps + safety concerns + quality issues) signal systemic problems requiring post-close operational restructuring.
Post-Close Implication
Facilities with visible red flags require more hands-on operational management post-close. This increases holding period costs and delays value realization. PE teams should factor this into EBITDA models and investment timelines.
Understanding operational red flags during due diligence shapes realistic post-close improvement planning and risk mitigation strategies.
