From LOI to Close: How to Prepare for Lender & Full Financial Due Diligence

A lot of times, deals die in diligence.

They don't die at the signing of the LOI. And very often, they don't die at the time of the purchase agreement. Deals often die in the beginning of diligence—those first 30 days or those first 60 days if it's a 90-day window.

To understand why, let's look at the story of one buyer's path to closing.

James' Acquisition Story

James signed an LOI for a $4 million home services company. He was expecting to close in 60 days.

Once the LOI was signed, James started to assemble his deal team. He engaged a CPA firm to conduct financial due diligence, began speaking with banks, and started staging the process the right way.

But the LOI period came with some bumps and twists and turns.

The EBITDA was coming in a little bit lower than expected. He was having challenges with what he thought was going to be his primary lending institution. James had to seek other banks, speak with other individuals, and assemble more of a deal team.

He brought in industry experience to take a look at the business. He had to get a land assessment and an environmental study done around his deal to pass regulatory concerns.

James' story is one that is a lot of what life looks like for trying to acquire a private small business.

There are twists and turns during the LOI period.

But James stuck to his guns. He kept the ball moving in the right direction.

The closing side of the story is what a lot of folks look toward. But doing things the right way and assembling the right group around you is how James was able to do this, along with his own responsibility as the sponsor for his deal.

The 90-Day LOI Timeline

So, what is a typical LOI due diligence timeline?

A typical LOI period is 90 days. If you are currently under LOI, it is helpful to think about when you should be pulling certain levers.

During days 1 through 30, you should typically begin financial due diligence with a CPA firm.

The reason is because often times in due diligence there may be challenges around the financials. Before you spend a bunch of money on legal, environmental studies, and other areas, you want to get a light verification of the financials out of the gate.

Secondly, you want to begin engaging with banks.

Whether you're doing an SBA bank, SBIC bank, or conventional debt, that process typically takes several weeks or months. You want to start this process right away.

Even if you've had preliminary conversations and maybe some term sheets or light indications of interest from banks, until you go under a formal underwriting process, you really aren't getting a look from their credit committee.

You aren't sure if they're going to confidently fund your acquisition.

Why Deals Fail During Due Diligence

A lot of the reasons deals die in diligence is because the numbers during the Quality of Earnings don't hold up.

They are materially different than what you thought the business was generating from revenue, expenses, and income in the pre-LOI position.

In James' deal, there was a material impact to net income.

The reported net income was about 20% lower due to a few one-time items discovered during due diligence.

And the reasonable earnings going forward were about 20% less than his perceived valuation.

This was one of the first turns in James' LOI period.

Financing Challenges Buyers Face

The next twist and turn was the lender James had in mind and who had a first look at his deal ended up walking away during underwriting.

This is why beginning the underwriting process early in the LOI period is so important.

Beginning underwriting shortly after, or in conjunction with, the Quality of Earnings allows you time to explore alternate financing options in the event the underwriters or bank ends up passing on the deal.

In James' deal, the SBA lender ended up walking away during the underwriting process.

The credit committee couldn't get coverage and some assurances around the deal, and they ended up passing.

The presumption was that the deal was going to close and that the lender was able to fund it.

This is why buyers who show up ready and do things almost immediately after LOI set the stage for the ability to close.

Certainty around closing really starts in the beginning of the LOI period.

If you are under LOI and you're still speaking with providers and trying to assemble a deal team, make a decision quickly and begin the processes with the companies you plan to hire as well as the banks you plan to speak with.

The longer you sit with the LOI and try to do things independently or on your own during the LOI period, the more you increase the probability that your deal will fall apart during due diligence because you're going to run out of time.

Several times per month, buyers want due diligence done in the later half of the period.

Quite frankly, there's not enough time to do a thoughtful exercise.

In those situations, it may be necessary to ask for an extension of the LOI period.

When we're talking about a multi-million dollar investment, it's very important that you give yourself the time to do a thoughtful analysis before you close the transaction.

What Lenders Actually Require

SBA and conventional lenders are underwriting the deal.

Not just the buyer.

Not just the seller.

They are going to strictly review the deal and then consider things like who is the buyer and what is the confidence post-close.

They are going to look for things like historical financials and tax returns, typically over a three-year period.

They are also going to look at cash flow and the debt service coverage ratio.

If you're exploring an SBA loan, debt service coverage ratio is the projected ability of the business to service the debt payments post-closing.

It is something you can calculate independently.

The typical debt service coverage ratio depends on the bank. The minimums around SBA banks are around 1.15, while many deals reaching closing are closer to 1.5 or 2 on a debt service coverage ratio.

New SBA Lending Rules

Effective June 1, 2025, the SBA rolled out some new SOPs around SBA-eligible loans.

One big change was that equity rollovers require a personal guarantee.

If sellers or investors are going to keep a piece of the equity post-closing, the SBA is now mandating a personal guarantee, depending on the structure of the agreement.

Minority investors under 20% ownership are skipping the personal guarantee, but there have been some changes around checks on who these investors are.

There are also considerations if you're pursuing a carveout.

If you're buying a piece of a larger business—for example, four of eight locations—that is what is called a carveout.

The financial data of a carveout is not going to tie back to the tax returns prepared by the company.

The reason is that the tax returns are including all of the entities owned by the owner.

If you're buying four of eight entities, it is very likely that revenues and expenses are going to be significantly less for the financials of the carveout than what is shown in the tax returns.

That is going to throw a wrinkle in the underwriting process.

It is very important to bring that up to the SBA underwriting committee ahead of time so they know what they are seeing.

Inside a Quality of Earnings Review

The Quality of Earnings review should be kicked off very close to once an LOI is signed.

The reason why is that this is a confirmatory audit and tests whether the numbers presented in the CIM or marketing materials actually hold up once you look under the hood of an accounting system.

Most small businesses' accounting systems are run on QuickBooks, QuickBooks Online, or desktop.

The first marching orders of the QofE are to gain access into the accounting records of the company and regenerate the financial data, ensuring that it is verified and accurate on a line-by-line basis.

That is the first sniff test of what the QofE does.

It then begins to look at the cash needs of the business, the ability for the business to cover its debt payments, and the revenue and customer durability of the business.

It is going to assess contract terms, customer concentration, and the sustainability of revenue going forward.

As a prospective buyer, it is very important that you gain comfort that the business's financial performance is going to continue in the foreseeable future.

An SBA loan is typically a 10-year term rate.

At a minimum, as you step in as a new owner-operator, you want to be able to sleep well at night knowing that the business you're buying today is the business that's been historically performing very well over the last three years.

That is, in essence, what a QofE and financial diligence review looks to achieve.

It is the confirmatory audit around the business.

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