The Deal Might Look Good, But These 5 Mistakes Could Cost You

When evaluating a business for acquisition, financial due diligence is what protects you from overpaying, missing critical issues, or stepping into an operation that cannot support its own debt. The following guide breaks down the most important risks to watch for and how to manage the LOI to close timeline effectively.

1. Asset Valuation Overstatements

Asset heavy businesses such as manufacturing or transportation often present inflated asset values. Depreciation schedules may not reflect the true condition of equipment. Real estate appraisals may rely on outdated or unrealistic assumptions. Capital expenditure needs are sometimes disguised as routine maintenance.

To protect yourself, verify the actual condition and market value of equipment and property. An independent appraisal provides significantly more detail than what an SBA lender typically orders. Investing in a proper valuation can save you from paying far more than the assets are worth.

2. Obsolete Inventory and Overstated Stock

Inventory heavy companies frequently show inventory at full value even when many items are no longer sellable. Components may have been sitting in storage for a decade. Raw materials may be outdated. Sellers often keep this inventory simply because they believe they can eventually move it.

Do not purchase obsolete inventory at full cost. Remove unsellable items from the transaction or price them based on today’s true market value. This ensures you avoid paying for stock that will never turn into cash flow.

3. Hidden Liabilities That Become Your Problem

Underreported liabilities are one of the most dangerous risks in a transaction. These issues usually appear only after closing unless you know where to look. Examples include unpaid payroll taxes, improper use of contractors, warranty obligations that remain outstanding, customer claims that have not been disclosed, and employee bonuses earned in a prior period but not paid.

In a stock sale these obligations transfer directly to you. In an asset sale you may still face pressure to resolve them in order to retain key customers and employees. Identifying these liabilities early allows you to negotiate escrow reserves or purchase price adjustments before signing.

4. The LOI to Close Timeline

Once an LOI is signed, the clock begins. Most deals provide sixty to ninety days of exclusivity. The most effective structure follows a clear sequence.

During the first thirty days focus on financial due diligence and bank underwriting. This is where you confirm revenue, validate earnings, review cash flow, and evaluate working capital. If the numbers are materially different from what was presented, you can exit before paying for legal and tax diligence.

During days thirty through sixty begin legal and tax diligence. This phase focuses on contracts, compliance, tax returns, corporate structure, and the drafting of the purchase agreement. The purchase agreement outlines representations and warranties, non competes, closing conditions, and all seller obligations.

During the final phase you complete negotiations, review final drafts, and prepare for transition at signing.

5. Knowing When to Walk Away

Walking away from a deal is painful but sometimes necessary. If the business cannot support the required debt service, the deal is not viable. If recent performance shows a sudden decline, you must determine whether the price needs to be renegotiated. If working capital requirements are significantly higher than what was presented, you may end up undercapitalized on day one.

If you choose to salvage the deal, reducing the loan amount, increasing the seller note, or restructuring payment terms may be required. However, it is often better to exit early than inherit a business that cannot sustain itself.

Watch the Full Webinar

If you want a deeper walkthrough of these concepts, including real examples, the full due diligence timeline, and the complete set of red flags to look for before closing a deal, you can watch the entire webinar recording. The session covers asset valuation, hidden liabilities, working capital, LOI structure, walk away rules, and how to assemble your deal team.

Pre LOI Information You Should Request

Before submitting an offer, request the most recent financials. At this point in the calendar year it is appropriate to ask for final results from the prior year as well as year to date numbers for the current year. Your primary concern is understanding performance over the trailing twelve to twenty four months. This period represents the business you are actually buying. Significant revenue declines or inconsistent margins should be identified before you determine your valuation.

Why a Clean and Professional LOI Matters

Your LOI serves as your presentation to the seller and broker community. A clear and professional document signals that you are a serious buyer. A poorly formatted or rushed LOI sends the opposite message. The acquisition world is smaller than most people realize and reputation matters. Present yourself as someone who is organized and committed to closing.

When to Bring in a Diligence Partner

You can engage a diligence partner for early guidance, but full financial diligence typically begins once the LOI is signed. A proper analysis evaluates the quality of revenue, the quality of earnings, customer concentration, margin structure, proof of cash, and working capital needs. Independent diligence protects you from bias and ensures your assumptions are grounded in data rather than hope.

Further Reading

If you want to dive deeper into topics like working capital adjustments, asset valuation, and hidden liabilities in small business acquisitions, the following resources provide valuable insights:

1. Net Working Capital in M&A — BDO

A clear explanation of why NWC adjustments matter, how pegs are negotiated, and how they impact the final purchase price.

2. Hidden Liabilities in M&A: How Contracts Make or Break a Deal — Pitcoff Law Group

Explains common hidden liabilities such as legal claims, contract obligations, and compliance issues that can surface after closing.

3. Worst Cases of Improper Asset Valuation — Transparently AI

A breakdown of major valuation failures and why accurate asset assessment matters, especially in asset heavy deals.

4. Working Capital Adjustment in M&A: A Definitive Guide — Valutico

Breaks down working capital mechanics, adjustment formulas, and how miscalculations can impact deal value.