You bought the asset. The Investment Committee loved the IP. The proprietary algorithm was validated by a Big 4 technical due diligence (TDD) team. The Black Duck scan came back clean. The code was, by all static measures, "elegant."
So why, six months post-close, has the product roadmap stalled? Why is the engineering team asking for a 30% budget increase just to keep the lights on? Why is EBITDA eroding instead of expanding?
Because you audited the artifact, not the factory.
This is the fundamental failure mode of modern Private Equity diligence. Traditional TDD answers static questions: Is the code secure? Are there IP violations? Is the architecture scalable? These are necessary, but insufficient. They miss the operational reality of how that technology is built, deployed, and maintained.
We call this the Operational Gap. While your TDD report confirmed the code was written in Python and hosted on AWS, it failed to mention that deployment is a manual, 4-hour process known only by one lead engineer who just resigned. It didn't flag that while the code is clean, the team spends 60% of their cycles on unplanned maintenance work.
For an Operating Partner, this distinction is not academic; it is financial. Technical debt is financial debt. If you buy a company with low static debt (clean code) but high operational debt (broken processes), you are acquiring a liability that will tax your Hold Period returns every single month.
Let’s look at the data. According to McKinsey’s 2024 research, CIOs estimate that technical debt amounts to 20-40% of the value of their entire technology estate. But here is the terrifying part for a PE sponsor: most of that debt is invisible to code scanners.
We distinguish between two types of debt during diligence:
When you miss Operational Debt, you inherit a "tax" on every future feature. Industry data suggests that companies with high operational debt pay an additional 10-20% premium on every dollar of new development. In a portfolio company where you need to accelerate growth to hit a 3x return, a 20% drag on velocity is fatal.
The cost becomes acute during integration. Harvard Business Review cites that upwards of 70% of M&A deals fail to achieve their anticipated synergies. Why? Because the acquirer underestimated the friction of merging two disparate operational engines. You might have aligned the balance sheets, but if one firm deploys daily and the other deploys quarterly, you do not have synergy—you have a collision.
We recently audited a mid-market SaaS acquisition that had passed standard TDD with flying colors. Our operational review, however, revealed that their "automated" QA process actually relied on a team of five manual testers in a low-cost geography. The cost of that manual labor was buried in COGS, not R&D. The result? A hidden margin impact that effectively lowered the valuation by $4M once adjusted.
To avoid the $2M mistake, Operating Partners must demand a new standard of diligence—one that fuses the technical with the operational. You need to assess the velocity of the asset, not just its validity.
Here is the breakdown of what to ask in your next diligence session to uncover operational reality:
If you uncover high operational debt, you don't necessarily kill the deal. You price it in. This is where Operational Engineering comes into play.
Your 100-day plan must shift from "fixing code" to "fixing the factory." Prioritize the implementation of CI/CD pipelines over refactoring old modules. Automate the deployment process before you rewrite the frontend. You can sell a company with messy code if it ships predictable revenue. You cannot sell a company that relies on heroics to keep the server running.
Ultimately, diligence is about risk pricing. Standard TDD prices the risk of a security breach. Operational Diligence prices the risk of execution failure. In a market where multiple expansion is no longer free, execution is the only lever you have left.
