The Pre-LOI Acquisition Checklist: What to Verify Before You Make an Offer on a Business
Before you sign a letter of intent on a small business, screen six areas: the quality of the earnings, customer concentration, how dependent the business is on its owner, legal and regulatory exposure, whether the deal will pass an SBA lender’s underwriting, and how candid the seller is with information. The purpose of that screen is not to finish due diligence. It is to decide whether the deal deserves due diligence at all, while walking away still costs you nothing.
This checklist is the framework a practitioner runs on a listing before writing an LOI. It is the hub for the detailed articles on this site: each section below tells you what to check and why, then points you to the piece that works that question through in full.
Why does pre-LOI screening matter more than full due diligence?
Because the LOI is the moment your leverage peaks and your commitment is still nearly free. Before it, you can ask for anything, walk away from anything, and negotiate price against everything you find. After it, exclusivity is running, professional fees are accruing, and every problem that surfaces is a problem you now have to solve rather than avoid.
Framed as practitioner judgment: most of what kills a small-business acquisition after the LOI was discoverable before it. Earnings that do not tie to the tax returns, add-backs that do not survive documentation, a customer who is a third of revenue, an owner who is the business, a debt structure that will not clear the lender’s coverage test: none of these are subtle, and none require a quality-of-earnings firm to find. They require the buyer to ask for the right documents and read them before making an offer. New buyers try to prove a deal is good. Experienced buyers try to prove it is bad, and proceed only when they cannot.
What documents should you request before writing an LOI?
At minimum: three years of business tax returns, monthly profit and loss statements for the same period, year-end balance sheets, business bank statements, a cash-to-accrual reconciliation if the books are on a cash basis, the seller’s schedule of add-backs with support, revenue by month and by customer, and a complete debt schedule. The list is deliberately the same list an SBA lender will assemble, because the lender’s file is the standard the deal ultimately has to meet.
| Document | What it establishes | Where the site goes deeper |
|---|---|---|
| Three years of business tax returns | The floor a lender underwrites to; the reconciliation target for everything else | How to read a broker-prepared P&L |
| Monthly P&Ls, three years | Seasonality, margin trend, the year the listing chose to feature | Same |
| Year-end balance sheets | Debt, receivables and inventory build, distributions, what the P&L hides | What is a working capital peg in an acquisition |
| Bank statements | Whether reported revenue actually arrived as deposits | Broker P&L article, reconciliation row |
| Cash-to-accrual reconciliation | Whether the presented earnings are on a basis a lender will accept | Broker P&L article, basis row |
| Add-back schedule with support | Which adjustments survive a buyer's and a lender's scrutiny | Which add-backs are legitimate in a business sale |
| Revenue by month and by customer | Trend, volatility, and concentration | This article, customer section below |
| Debt schedule, UCC filings, leases | What the business owes and what a buyer would assume | Asset sale vs. stock sale |
Ask for all of it at once, at the same time you request the CIM, and note how long it takes to arrive and how complete it is when it does. A seller who cannot produce three years of returns and a debt schedule inside a week is telling you something about the bookkeeping you would inherit.
How do you test earnings quality before an LOI?
Three tests, in order, and each has its own article on this site.
Does the presented P&L tie to the tax returns? Reconcile revenue, cost of goods, and total expenses by year against the filed returns and get every difference explained. An SBA lender will do this against IRS transcripts as a matter of rule, and will underwrite to the returns where the P&L shows more. (Source: SBA SOP 50 10 8, Section B, Chapter 1 (financial information and IRS transcript verification); SBA SOP 50 10 8.1, Appendix 15 (financial reporting hierarchy and transcript verification).) The full checklist is in how to read a broker-prepared profit and loss.
Which add-backs hold? Every claimed adjustment needs a document behind it and needs to be genuinely non-recurring, personal, or non-cash. Adjustments that assume savings the buyer will achieve, or that recur every year under a different label, do not hold. The framework is in which add-backs are legitimate in a business sale.
What are the earnings on the basis a lender will use? Brokers present SDE, which adds back one owner’s full compensation. SBA lenders underwrite on an EBITDA-based measure adjusted item by item, with the owner’s compensation set at a level that supports the owner’s obligations. The gap between those two numbers, on an owner-operated business, is often the whole margin between a deal that covers and one that does not. See what is SDE and how is it different from EBITDA and, for the specific adjustment, does owner salary reduce SBA debt-service coverage.
One more point that belongs in this section because buyers get it wrong constantly: EBITDA is not cash flow. It ignores debt service, taxes, capital expenditure, working capital, and the cost of replacing the owner. A business with strong EBITDA can fail an acquisition loan once those are modeled, and why can a profitable business fail SBA underwriting walks through exactly how.
What customer information should you analyze, and how much concentration is too much?
Analyze revenue by customer for each of the last three years, the share of revenue held by the largest customer and the top ten, retention and churn, accounts receivable aging, and whether the customer contracts transfer to a new owner. Then ask the only concentration question that matters before an LOI: if the largest customer leaves in the first year after closing, can the business still service its acquisition debt and meet payroll?
The thresholds buyers use to sort concentration are practitioner judgment, not rules, and they should be read that way. In practice, a common working scale treats a largest customer under roughly 15 percent of revenue as diversified, 15 to 25 percent as manageable with attention to the relationship, 25 to 35 percent as elevated risk that should be reflected in structure or price, and anything much above that as a concern serious enough to reshape or end the deal. Those bands are how many experienced buyers and lenders think about it; they are not SBA rules and no source sets them. What makes concentration more dangerous at any level is when the relationship depends personally on the seller, when the contract cannot be assigned, or when that customer’s margin differs materially from the rest of the book.
Concentration is rarely fatal by itself. It changes structure: an earnout tied to retention, an escrow, a larger seller note, customer interviews before closing. And it changes the coverage math, because a lender modeling the loss of a 30 percent customer will find that a deal which cleared coverage on the full book no longer does. The stress test is the same reverse-DSCR arithmetic used in how much debt can a small business support, run on revenue less the largest account.
Contract transferability sits alongside concentration. Whether contracts assign, whether assignment requires customer consent, whether pricing is locked and renewals are near, and whether a change of control lets the customer walk are legal questions for your counsel, and they weigh differently in an asset purchase than in a stock purchase, as covered in asset sale vs. stock sale.
Which operational documents reveal owner dependence?
The organizational chart, payroll register, employee roster and tenure, contractor list, supplier contracts, equipment list and ages, licenses and permits, and the employment agreements for anyone the business cannot run without. Together they answer whether the business is a company or a person with a payroll.
Owner dependence has a price, and the price comes out of coverage. If the seller runs operations, sells, and keeps the books for a salary that a market manager would not accept, then the P&L understates the cost of running the business by the difference, and a lender will put that difference back before testing coverage. The article on replacement manager salary and DSCR works the adjustment; the practical screen is the five questions below.
What five questions should you ask the seller?
Documents tell one story and conversations tell another, and asking the same question more than once over the course of a deal is the cheapest consistency test there is.
- Why are you selling now? The answer matters less than whether it stays the same each time you ask.
- What is the biggest problem a new owner will inherit? Candid sellers name one. Sellers who say there is none deserve more scrutiny, not less.
- Which customer relationships depend on you personally? This is the concentration question asked from the other side.
- If you were gone for a month, who would run it? A specific name is a good answer. “It would be fine” is not.
- What has the business put off? Deferred maintenance, equipment past its life, a hire that should have been made, software that should have been replaced. Whatever was postponed becomes your capital expenditure in year one, and it belongs in the coverage model.
Which financial ratios should you review first?
Before paying for a quality-of-earnings review or legal diligence, look at six things: EBITDA margin and its trend, seller’s discretionary earnings and how much of it is add-backs, debt-service coverage at the price and structure being discussed, working capital and its seasonality, gross margin trend, and revenue growth over multiple years. The aim is not a scorecard. It is to find out whether the business can carry acquisition debt and still leave the buyer cash after paying it.
- EBITDA margin. The level matters less than the direction. Rising margins usually mean operational improvement; falling margins need an explanation before the price is agreed.
- SDE and its composition. How much of the presented earnings figure is add-backs, and how many of them hold. See what is SDE.
- Debt-service coverage. The ratio an SBA lender will actually test. What counts as a good number, and how the calculation is built, are in what is a good DSCR for an SBA business acquisition and how is DSCR calculated when buying a business. What price the coverage supports is in how much can I pay for a business and still meet DSCR.
- Working capital. Whether the business needs cash to operate that the P&L does not show, and who funds it at closing. Profit is not liquidity; a profitable business bought without its working capital runs short in month two.
- Gross margin. Trend and consistency. A margin that jumps in the listing year without an operational reason usually means something was reclassified.
- Revenue growth. Over several years, not one. A single strong year is a data point, not a trend.
Ratios only mean something against businesses of similar size, industry, labor model, and capital intensity. This site does not print industry benchmarks it cannot source; where a comparison is needed, use a source that states its data and period, and match on size before comparing multiples or margins. See how does a seller note affect DSCR for how the financing structure changes the coverage ratio you should be looking at.
What are the biggest pre-LOI red flags?
The signals that show up most consistently in deals that later collapse. None is fatal alone; several together usually are.
| Red flag | Why it matters | Where it is worked through |
|---|---|---|
| Large add-backs without documents | The valuation rests on earnings that may not exist | Which add-backs are legitimate |
| Cash-basis books with no reconciliation | Timing can move a year's profit; a lender will restate it | How to read a broker P&L |
| P&L more profitable than the tax returns | The lender underwrites to the returns; the difference disappears from the loan | Same |
| Family members on payroll with unclear roles | Either hidden compensation or hidden labor the buyer must replace | Does owner salary reduce DSCR |
| Receivables aging past 90 days | Collection risk, or revenue that was booked and never collected | Broker P&L article, balance sheet row |
| Inventory growing faster than revenue | Obsolescence, or purchases parked on the balance sheet to flatter margin | Same |
| Revenue spike in the listing year | One-time contract or pulled-forward sales that will not recur | Same, revenue quality row |
| Owner does a job the buyer will not do | Replacement cost comes out of coverage | Replacement manager salary |
| Largest customer above a quarter of revenue | Coverage may not survive the loss of one account | This article, customer section |
| Slow or partial document production | The bookkeeping you would inherit, and the diligence you would pay for | This article, documents section |
How do SBA lenders evaluate an acquisition, and what should you check first?
An SBA 7(a) lender tests the acquired business’s historical cash flow against the debt service the deal will carry, verifies the financials against IRS transcripts, obtains an independent business valuation, and requires the buyer to inject equity. The specific rules are dated, and a buyer should know which version applies to their closing.
This is general information about SBA program rules, not advice for your specific loan. Confirm the SOP version and your lender’s own methodology with your lender.
Under SOP 50 10 8 (effective June 1, 2025, in force as of this article’s review date), a Standard 7(a) loan requires debt-service coverage of at least 1.15x on a historical and/or projected basis, with operating cash flow defined as EBITDA and debt service including the new SBA loan and all other business debt. Under SOP 50 10 8.1 (effective October 1, 2026), an Initial Acquisition change of ownership requires 1.25x, measured as EBITDA over combined post-transaction debt service on a historical or lender-adjusted basis, with projections not relied on. The total debt supporting the transaction, including any seller note not on full standby, is limited to the business valuation, and the buyer must inject at least 10 percent of total project costs in equity, which under 8.1 cannot be reduced. Seller debt on full standby for the life of the SBA loan may count toward equity, up to half of the required injection; seller debt that requires payments during the SBA term is debt service. And under 8.1, the seller in an initial acquisition generally may not remain as an officer, director, stockholder, or employee after the sale, apart from a consulting arrangement not exceeding 24 months. (Source: SBA SOP 50 10 8, Section B, Chapter 1 (Standard 7(a) underwriting, financial analysis of repayment ability; change of ownership equity and seller-debt provisions); SBA SOP 50 10 8.1, Appendix 15 (Initial Acquisition DSC, business valuation limit, equity injection, seller standby debt, seller post-sale role).)
Framed as practitioner judgment: run the lender’s test yourself before you write the LOI. Take the earnings you have restated (not the broker’s SDE), subtract the cost of the owner’s role if you will not fill it, model the debt service at the price and structure on the table including any seller note that requires payments, and see whether the result clears the coverage floor with room to spare. If it does not, the deal is not financeable as priced, and the LOI you are about to write is a price you cannot pay. The full chain, from normalized earnings to the maximum price a deal supports, is in how much can I pay for a business and still meet DSCR.
Structure belongs in the same check. Whether the deal is an asset purchase or a stock purchase changes what you inherit and what you can depreciate, and it should be settled before the LOI fixes the form; asset sale vs. stock sale covers the decision.
How does a practitioner actually run this screen?
Framed as judgment, the process is shorter than the checklist makes it look, because most deals fail early.
- Request the document set on the day you request the CIM. Note what arrives, when, and how complete it is.
- Reconcile the P&L to the returns. If it does not tie, stop until it does; everything downstream is unreliable.
- Rebuild the earnings two ways: the SDE you would defend and the adjusted EBITDA a lender would compute. Test every add-back.
- Take out the owner’s role if you will not perform it, at a market cost.
- Run coverage at the asking price and the likely structure. Then run it again with the largest customer removed and again with the deferred capital expenditure funded.
- Read the balance sheet for working capital, debt, and what the P&L hides.
- Ask the five questions, then ask them again a week later.
- Decide among three outcomes: proceed and write the LOI, renegotiate price or structure to fit what you found, or walk. All three are good outcomes at this stage. The only bad outcome is discovering the same facts after exclusivity.
Related and next steps
This checklist is the hub. The deep articles, by area:
- What is SDE and how is it different from EBITDA? →Earnings quality: the two measures and the gap between them.
- Which add-backs are legitimate in a business sale? →Earnings quality: the defensibility framework.
- How to read a broker-prepared profit and loss →Earnings quality: the reconciliation checklist.
- What is a good DSCR for an SBA business acquisition? →Coverage: the dated SOP thresholds.
- How is DSCR calculated when buying a business? →Coverage: the formula and a worked example.
- Does owner salary reduce SBA debt-service coverage? →Coverage: the replacement-manager adjustment.
- How does a seller note affect DSCR? →Coverage: standby versus paying seller debt.
- Why can a profitable business fail SBA underwriting? →Coverage: profit is not coverage.
- How much debt can a small business support? →Price: the reverse-DSCR calculation.
- How much can I pay for a business and still meet DSCR? →Price: the full chain from earnings to maximum price.
- Asset sale vs. stock sale: which is better for buyers? →Structure and tax.
- SBA-financed business acquisitions →The SBA transaction type end to end, for financed buyers.
NexTax Advisory's buy-side services cover earnings recasting, coverage stress testing, and pre-LOI modeling, so the LOI you write is one a lender will finance.
To run the coverage arithmetic on a listing yourself, the free SBA Deal Check in AcquiFlow takes the earnings, price, and structure and shows whether the deal clears the coverage thresholds above.
An earlier version of this checklist appeared on nextax.ai on July 22, 2026. It has been revised and moved here.
Steve Morello is the founder of NexTax Advisory. His career spans corporate tax and transaction-related tax matters across private-equity and investment-fund environments, including experience at EY and Morgan Stanley. Today he applies that financial and tax background to lower-middle-market acquisitions and exits, and is the creator of AcquiFlow, pre-LOI underwriting software for SMB buyers.
Published July 22, 2026. Materially reviewed August 18, 2026. This article is general information, not advice for your specific situation. NexTax Advisory provides financial and tax advisory services and does not provide legal services or formal audit or attest engagements. Consult your own attorney, lender, and accountant on your specific transaction.