Due diligence
Turn a red flag into a question you can answer
A warning is useful when it names the evidence you need and the decision that evidence will change.
A low asking multiple can hide a costly transition. A high multiple can still deserve a closer look. The first screen helps allocate your attention; documented earnings, contract terms and a workable operating plan determine what comes next. This checklist is a suggested review process, not a universal pass/fail standard.
Earnings that depend on explanations
Ask for a line-by-line bridge from the accounts to stated SDE. For each adjustment, record its amount, the expense account, supporting document, why it will not recur and who will perform any work being removed. If a supposed one-time expense appears in multiple years, model it as recurring until there is evidence otherwise.
Keep a seller case and a buyer case. An unsupported $20,000 adjustment changes an illustrative 3× earnings valuation by $60,000. That arithmetic is a reason to request evidence, not proof of the right valuation multiple.
Concentration without a transition plan
A large customer is a question about cash flow and retention. Request revenue and gross profit by customer, contract duration, renewal dates, assignment terms and any recent disputes. Model the contribution lost if that customer leaves; do not subtract revenue dollar-for-dollar from SDE when some costs would also disappear.
Record which relationship belongs to the company and which depends on the seller personally. A reassuring conversation is different evidence from an assignable contract.
Owner dependency hidden by an add-back
List what the seller does in a normal week: estimating, dispatch, technical work, customer relationships and administration. Assign a realistic replacement cost and confirm required skills or licenses. When several family members work in the business, document their duties and total replacement cost separately.
Equipment and premises that consume the reserve
Request equipment age, condition, maintenance history, liens and replacement estimates. Pair an operating cash-flow model with a separate schedule for near-term purchases. For premises, have counsel review assignment, renewal, rent escalations and required consents before relying on continued occupancy.
Working capital that disappears at closing
Write down what is included in the price: inventory, usable supplies, receivables, customer deposits and operating liabilities. An attractive earnings figure does not specify the cash required to run the business during its first month. Ask the accountant and attorney to reconcile the proposed closing terms with the operating budget.
Record a decision that can be revisited
| Finding | Evidence requested | Possible next step |
|---|---|---|
| Add-back lacks support | General ledger and invoice | Exclude it from the buyer case |
| Large customer may leave | Contract and retention discussion | Stress-test the contribution loss |
| Seller performs a licensed role | License requirements and staffing plan | Cost a qualified replacement |
| Equipment replacement is near | Inspection and written estimate | Adjust reserves or transaction terms |
| Lease consent is uncertain | Landlord response and counsel review | Resolve before committing |
Use the diligence workspace to mark a risk, save the document reference and name the next action. Reviewed means someone looked at it. Resolved means the concern has a documented answer. A deal can have all nineteen checks reviewed and still deserve a pass.
The SBA recommends reviewing the financial and operating picture of an existing business and working with qualified help. See its business planning resources, including buying an existing business. The examples and decision workflow above are Arcane's educational framework.