Buying a small to medium-sized business is one of the most exciting—and risky—ventures. It's known as the riskiest asset class. Whether you're signing a personal guarantee or taking on private debt, you're risking significant capital.
That's why thorough due diligence is essential. It protects your investment and ensures you're viewing the business through the right lens.
Once a signed letter of intent (LOI) is in place, your due diligence period begins. Expect a 30, 60, or 90-day timeline. The LOI grants exclusivity and signals serious intent.
Start financial due diligence and SBA underwriting immediately. At Day 30, begin tax diligence. By Day 60, initiate legal diligence and start drafting your purchase agreement.
1. Revenue Verification
Ask: Is the revenue real, recurring, and stable?
Analyze financial statements in QuickBooks or similar software
Review proof of revenue using 12-month bank statements
Compare receipts to reported revenue (within ±2% variance)
2. Expense Analysis
Understand actual expenses versus discretionary costs.
Owner salaries, personal travel, bonuses—check if they’ll continue post-close
Watch out for excessive add-backs in broker SIMs
Travel expenses often stay; salaries can change
3. Cash Flow Truth
Free cash flow is what pays your SBA or private loan and your salary.
Build a pro forma with debt layered in
Assess whether the business supports expected debt loads
4. What’s in the Balance Sheet
In asset sales, understand what you're buying:
Accounts receivable
Equipment
Other selected items
Before we continue, watch this full webinar breaking down the due diligence process step-by-step. It highlights key areas like revenue verification, working capital, and deal structure analysis.
Now, let’s dive deeper into how to analyze income statements during due diligence.
Margins Matter Review:
Gross Profit Margin = Revenue – Cost of Goods Sold
EBITDA Margin = Operational Performance
Net Profit Margin = Revenue – All Costs
Look for margin swings. A drop from 25% to 10% or spike to 70%? Ask why.
Qualitative + Quantitative
Quantitative = financial deep dives
Qualitative = strategic questions to understand the root of fluctuations
Unexplained revenue spikes
Declining margins
Poor financial records
Customer concentration (5–6 customers = 75% revenue)
Cash vs. accrual discrepancies
Seasonality in cash flow
These red flags may require you to lower the purchase price or restructure terms—like increasing the seller note.
For a deeper dive into the components of a Quality of Earnings (QoE) report—like revenue recognition, EBITDA adjustments, and working capital—check out this guide by the Corporate Finance Institute. It complements the insights shared in our webinar and provides helpful examples for understanding how QoE impacts business valuation.
Adjust for one-time events.
$450,000 lawsuit? Likely won’t repeat. Add back.
One-time customer project? Don’t count on repeat business.
Owner compensation should be benchmarked (e.g., $100K–$150K) and offset in your EBITDA calculation.
Included or excluded in purchase price?
What assets/liabilities are in it (A/R, A/P)?
Set a target, then compare to closing figures
It’s complex—consider expert help
This section can make or break your deal. It’s complex and highly negotiable and consider bringing in an expert to help you navigate it.
Read our full blog on how to calculate and negotiate working capital in M&A deals:
Understanding Working Capital in M&A
M&A CPA (Quality of Earnings)
M&A Attorney
SBA lender or private bank
Industry expert (optional, possibly equity-based)
Excessive trust in seller
Accepting vague responses
Not verifying with financial data
Rushing into closing without complete reviews
Missing written terms in purchase agreement
If you're under LOI or searching actively, financial due diligence is your foundation for making the right decision. Trust the seller—but verify everything. Every line item, every margin, every bank statement.
Diligence gives you the insight to walk away from bad deals—or to negotiate better ones.
Contact us today to learn how we can support your next deal.