The Operational Due Diligence Checklist for Acquiring a Defense or Aerospace Manufacturer

Target keyword: operational due diligence checklist defense manufacturer acquisition

Why Standard Financial Due Diligence Misses What Kills Defense and Aerospace Deals

Financial due diligence tells you what the company earned. It does not tell you how hard it was to earn it, what it cost to hold the operation together while it earned it, or whether the conditions that produced last year's results still exist. In defense and aerospace manufacturing, the operational underpinnings of revenue are fragile in ways that do not appear in an income statement.

A company that earned $4M EBITDA last year while running a key program manager into the ground, absorbing $600K in untracked rework, and carrying 18 months of backlog built on cost estimates that are now 22% below current material prices looks identical to a company with none of those problems when you are reading a CIM. They are not the same company.

The operational due diligence process needs to answer a different set of questions. Are the delivery commitments in the backlog executable with the current workforce? Are the margins on awarded programs based on cost assumptions that still hold? What happens if the two senior engineers who carry the institutional knowledge of the legacy product line walk out at close?

These are not hypothetical risks. They are the specific failure modes that cause defense and aerospace acquisitions to miss their first-year EBITDA targets by 20 to 40 percent. Finding them before the LOI is signed is the difference between a realistic integration plan and an expensive surprise.

Six Operational Areas That Determine Post-Acquisition Value

Start with the backlog. How many open orders are past due today? What percentage of backlog is on programs where the original cost estimate is more than 18 months old? Does the master production schedule exist as a real, resource-loaded plan, or as a list of dates nobody owns?

In defense and aerospace, a backlog is only an asset if the operation can execute it at the margins it was priced at. A company carrying $12M of awarded contracts at 28% gross margin is a very different situation if $4M of that backlog is priced on 2023 component costs and those components are now 30% more expensive. The backlog number on a data room slide does not include that adjustment. Your operational assessment needs to make it.

Mid-market defense manufacturers typically have two or three individuals who carry disproportionate institutional knowledge: the program manager who manages the prime contractor relationships, the quality director who owns the AS9100 certification, the senior engineer who understands a legacy product's manufacturing constraints. These people are rarely identified in a CIM, and they are often not well-compensated relative to their market value.

Identify them before close. Understand their compensation, their equity position if any, and their intention post-transaction. A retention arrangement for the right two or three individuals often creates more deal value than any operational initiative in the first 12 months. The absence of one of them at the wrong moment can put a key program at risk.

Is one program greater than 30% of revenue? When does the prime contract underlying that program come up for re-compete? Has the company received any corrective action requests, cure notices, or past performance concerns from a government contracting officer or DCMA within the last 36 months?

One undisclosed quality escape or a past performance rating of "satisfactory" rather than "very good" has direct implications for the next source selection. Defense customers have long institutional memories. Past performance ratings follow a contractor into every competitive bid for five years. A company with a marginal past performance record is worth less than its backlog implies, and that discount needs to be in the model before you sign.

Request the last internal quality audit, the most recent AS9100 or Nadcap surveillance results, and the open corrective action log. Pay particular attention to how many corrective action report items have been open longer than 90 days.

A quality system that is technically certified but operationally deferred, meaning real findings are closed on paper but not resolved in practice, is a liability that will surface in the first customer or DCMA audit under new ownership. Quality systems that were maintained by the personal attention of one or two senior quality leaders are also vulnerable to departure. The certification belongs to the company; the knowledge that keeps it current belongs to specific people.

Defense electronics assembly and aerospace fabrication require trained, experienced technicians who cannot be replaced quickly. The relevant questions are not only how many people the company employs, but what the voluntary turnover rate was in the last 12 months, how many current employees have less than 12 months of tenure, and whether the company is relying on overtime to sustain output that its headcount cannot maintain at straight time.

A workforce running at 15% overtime every week is not a stable workforce. It is a workforce one scheduling disruption away from a delivery miss. That condition appears in labor cost as a percentage of revenue, but it does not appear anywhere as "we are burning out the people we need most." Operational due diligence surfaces it. Financial DD does not.

Ask to see how the company builds its master production schedule. Ask whether the bill of materials in the ERP system matches the drawings being built to today. Ask what percentage of inventory in the system has been verified against a physical count in the last 90 days.

Companies with poor ERP data integrity have production planners making decisions based on tribal knowledge rather than system data. The system says there are 47 units of a critical subassembly in stock; there are actually 12 because the rest were consumed on a work order that was never closed out. This fragility is invisible to financial due diligence and catastrophic when new ownership arrives expecting to manage by the system and finds that the system cannot be trusted.

When to Place an Interim Operator at or Before Close

If operational due diligence surfaces two or more of the six risk areas above, the deal may still be sound, but it needs an operating plan alongside the integration plan. The distinction matters: an integration plan merges org charts and consolidates vendor contracts; an operating plan fixes the specific conditions that will cause the first 12 months to underperform the model.

The highest-return decision a PE sponsor can make in this situation is placing an experienced interim operator, a COO or VP of Operations with direct defense or aerospace manufacturing experience, in the business at or shortly after close. Their job is not to run the company permanently. Their job is to stabilize the operation, build the functional leadership team, and construct the management infrastructure the permanent team will inherit. A three-to-six month interim engagement costs a fraction of a single missed year-one EBITDA target.

The interim operator is also the most effective hedge against the key person risk identified in the due diligence. If a senior program manager or quality director walks at close, an experienced interim leader knows how to absorb that loss without losing the program. That knowledge does not exist in a financial model. It exists in the operator.

If your firm is evaluating a defense or aerospace manufacturing acquisition and needs an operational assessment before close, Wentworth Global Advisors conducts operational due diligence for PE sponsors and places experienced interim executives at close. The first conversation is a direct discussion of what we would look for and what we typically find in situations like yours.

Frequently Asked Questions