The Missing Layer of Diligence in Lower Middle-Market Services Businesses
When a private equity firm acquires a tech-enabled services business today, technology diligence is no longer viewed as optional. Buyers expect to understand the quality of the underlying infrastructure and architecture, the level of technical debt, the scalability of the platform, the security posture, and the amount of investment that will likely be required after the transaction closes. Years ago, these conversations were often reserved for the largest transactions, or for businesses whose primary asset was a software or SaaS product. Today, they have become a routine part of almost every meaningful acquisition because investors have learned that the technology supporting the business often determines whether it can successfully execute on its growth plans after closing.
Professional services businesses present a similar challenge, but the asset that deserves the same level of scrutiny is not only the technology stack, it is also the operating model. You can think of the operating model as the architecture of a services business or the system by which the organization consistently turns demand into profitable delivery, encompassing the processes, data, decision-making, governance, technology, and management discipline that connect sales, staffing, delivery, finance, and executive oversight into a repeatable way of operating. It is the framework that determines whether growth translates into predictable execution, healthy margins, and scalable financial performance.
This is something that has become apparent to me after spending the better part of two decades leading a digital consulting business through multiple phases of growth, acquisitions, and ultimately a private equity investment, and now working alongside services businesses and investors as they evaluate opportunities for growth and value creation. Financial diligence has become increasingly sophisticated with Quality of Earnings analyses going deeper than they have ever been, commercial diligence does a far better job than it once did of evaluating market positioning and growth potential, and as already discussed, technology diligence has become standard practice. Yet there is still remarkably little attention paid to understanding how a services business actually operates on a day-to-day basis, how decisions are made, and where the constraints on future growth are likely to emerge.
That gap matters because, unlike many other industries, the operating model is not simply an internal function that supports the business. In many ways, it is the business.
A professional services firm creates value through thousands of operational decisions every month: how opportunities are qualified, how work is estimated, how projects are staffed, how utilization is managed, how delivery issues are surfaced, and how leaders make decisions when priorities inevitably compete for finite capacity. These are not isolated operational activities; together they determine whether revenue is predictable, whether margins expand or erode, whether hiring keeps pace with demand, and whether the organization can continue to grow without placing increasing pressure on the people responsible for running it.
Most lower middle-market services firms have reached their current scale through talented people, strong client relationships, and years of practical operating experience. Many are exceptionally well-run businesses. At the same time, they have often grown around founders and leadership teams who possess an extraordinary amount of institutional knowledge. Decisions that appear systematic from the outside are frequently driven by intuition developed over years of operating the business. Forecasts may ultimately prove accurate, but they often depend on a handful of experienced leaders reconciling information across various systems and weekly conversations. Capacity planning and resource management works because one or two executives know every client, every project, and every employee well enough to connect the dots manually before problems become visible to everyone else.
There is nothing inherently wrong with that approach while the business remains at a certain size, and in many cases, it is precisely what enabled the business to become successful. The challenge is that these characteristics rarely appear during diligence, despite representing some of the largest sources of execution risk after an acquisition.
Traditional diligence asks important questions. Are revenues recurring? Are margins sustainable? How concentrated is the customer base? Are contracts assignable? What adjustments should be made to normalized EBITDA? Those are all essential questions, and every investor should understand those answers before making an investment.
But what traditional diligence does not typically reveal is whether management can reliably forecast the next two quarters, whether project profitability can actually be measured before the month closes, whether hiring decisions are being made proactively or reactively, how quickly leadership recognizes delivery issues as they begin to emerge, or how dependent the organization is on a small number of individuals making dozens of operational decisions based on experience rather than shared systems and processes.
Those questions become particularly important because they influence almost every aspect of post-acquisition value creation. Revenue shortfalls are often attributed to weakening demand when, in reality, they originated months earlier through capacity constraints that were never visible. Margin compression is frequently blamed on pricing pressure when the underlying issue was poor visibility into project economics or inconsistent staffing decisions. Hiring becomes reactive because there is no reliable way to forecast future demand, creating a cycle where growth opportunities are missed while new employees are recruited and onboarded. As a result, leadership teams spend their first year under new ownership building reporting infrastructure and operating discipline rather than executing the commercial initiatives that formed the basis of the investment thesis.
None of these issues necessarily prevent a successful acquisition. In fact, many represent exactly the kinds of opportunities investors hope to improve. The concern is not that these operating characteristics exist. It is that they often remain largely invisible until after the transaction has closed.
That is not because private equity firms underestimate the importance of operations, in my experience, the opposite is true actually. Most investors spend significant time evaluating management teams, discussing operational priorities, and developing value creation plans well before a transaction closes. The challenge is that lower middle-market professional services businesses operate differently than many of the industries where traditional operating diligence has been developed.
The mechanics that determine whether a services business can successfully scale are often subtle. They are found in the way work is estimated, how resources are allocated across competing priorities, how forecasts evolve as opportunities move through the pipeline, how delivery performance is measured, how project profitability is understood before the financial statements are finalized, and how leadership teams balance growth and client commitments every week. These are not simply operational processes, but rather they are the mechanisms through which the business creates enterprise value.
None of these observations should necessarily change an investor's willingness to pursue a transaction. In fact, many represent exactly the kinds of operational improvements that create meaningful value over the life of an investment. The important distinction is that these constraints should be understood during diligence, not discovered during the first year of ownership. A clear understanding of where the operating model begins to limit scalability allows investors to underwrite the appropriate investments, establish realistic value creation priorities, and build post-close operating plans based on the realities of how the business functions today, rather than assumptions about how it should function.
This is where I believe the industry has an opportunity to evolve its approach to diligence.
Rather than viewing the operating model as something that management will naturally improve after closing, investors should evaluate it with the same rigor that they apply to financial, commercial, and technology diligence. Not because they expect perfection, but because understanding how decisions are made provides far greater insight into how the business will perform under new ownership than historical financial performance alone ever can.
Questions such as how forecasts are produced, how resource allocation decisions are made, whether project margins can be measured in real time, how delivery risks are identified, how leadership meetings are structured, and which operating metrics actually influence executive decisions tell a much richer story about an organization's ability to scale than a historical income statement. More importantly, they help distinguish between businesses whose performance depends on extraordinary individuals and those that have built repeatable operating systems capable of supporting the next phase of growth.
I increasingly think of this as the missing layer of diligence for lower middle-market professional services businesses.
Just as technology diligence seeks to understand whether a software platform can support future growth, operating model diligence seeks to understand whether the organization itself can support the ambitions outlined in the investment thesis. It provides visibility into how work actually moves through the business, where operational friction exists, where leadership capacity becomes constrained, and where the greatest opportunities for value creation are likely to be found.
As private equity firms continue to look for ways to create value beyond financial engineering, I believe this perspective will become increasingly important. The next generation of value creation in professional services will not come solely from better financial analysis or stronger commercial strategies. It will come from a deeper understanding of how these businesses actually operate, where their operating model begins to constrain growth, and what investments will unlock the next stage of performance.
For professional services businesses, the operating model is not simply an internal process. It is the mechanism through which every commercial strategy, every hiring decision, every client engagement, and ultimately every dollar of EBITDA is produced.
Understanding how that mechanism works should no longer be considered an operational exercise, it should be considered a fundamental part of understanding the investment itself.