When evaluating a business acquisition, the period before submitting a Letter of Intent (LOI) is critical. This is your chance to conduct high-level due diligence, assess deal viability, and ensure you’re not about to buy a business held together by duct tape and wishful thinking. Buyers at all levels should approach this stage with a strategic mindset to avoid costly mistakes down the line.
Rushing into an LOI without proper vetting can lead to wasted resources, unexpected risks, and even deal failure. Taking the time to scrutinize key aspects of the business early on will put you in a stronger position during negotiations and increase the likelihood of a successful acquisition. Here’s what you should be looking for before taking that leap.
Financial Health: Are the Numbers Solid?
A business may look profitable on the surface, but a closer examination of its financials can reveal hidden issues. At this stage, you won’t have access to full financials, but you should still look for red flags. Request key financial documents such as:
- Revenue and Profit Trends – Are sales growing, declining, or flat? A declining trend may signal underlying business challenges that could impact future stability.
- Profit Margins – How does the company’s margin compare to industry standards? If the business is operating on razor-thin margins, you might end up working harder for less.
- Revenue Concentration – Are earnings reliant on a few key clients or a diverse customer base? A heavy reliance on a single customer can be a major risk if they decide to leave.
- Debt and Liabilities – Does the business carry manageable debt? High debt levels can impact cash flow, limit reinvestment opportunities, and create financial strain.
If the financials don’t add up or seem inconsistent, it’s time to hit pause before proceeding.
Owner Involvement: How Dependent is the Business on the Seller?
A business that heavily relies on the current owner can be risky. If the seller is the glue holding everything together, you need to assess what happens when that glue is gone. Consider:
- Day-to-Day Involvement – Is the owner running everything? If their departure means the business crumbles, that’s a problem.
- Key Employees – Are there experienced employees who can sustain the business post-sale? Or will they follow the owner out the door?
- Process Documentation – Are workflows and standard operating procedures documented? A lack of documentation means valuable knowledge might disappear with the seller.
If the owner’s departure would cripple operations, make sure there’s a transition plan before moving forward.
Customer Base and Market Position
A business’s sustainability and growth potential largely depend on its market position and customer base. A company that’s profitable today might not be so tomorrow if it’s riding a sinking ship. Look at:
- Customer Diversification – Is revenue spread across many clients or concentrated on a few? Losing one big client shouldn’t spell disaster.
- Market Trends – Is the industry growing, stable, or in decline? A booming market is great, but if the industry is shrinking, you’ll need an innovation game plan.
- Competitive Landscape – What differentiates the business from competitors? If there’s no competitive advantage, price wars may become your new reality.
If the business operates in a shrinking market or lacks a competitive edge, it’s worth reconsidering your interest.
Operational Efficiencies and Risks
Even if the financials look great, inefficiencies can quietly erode profitability over time. Be sure to assess:
- Employee Retention – Does the business struggle with high turnover? A revolving door of employees can indicate management or morale issues.
- Supplier and Vendor Relationships – Are key suppliers reliable? If a single supplier holds all the power, that’s a risk.
- Legal or Compliance Issues – Are there pending lawsuits or regulatory concerns? Nothing says “buyer’s remorse” like unexpected legal battles.
Operational headaches can significantly impact profitability and growth potential.
Technology and Infrastructure
In today’s market, technology plays a crucial role in business efficiency and scalability. If the company’s still running on software last updated in the early 2000s, you’ll want to factor in upgrade costs. Consider:
- System Modernization – Will you need to invest in new software or infrastructure? Outdated systems can be costly to replace.
- Automation and Scalability – Can the business grow without major reinvestments? Scalable technology makes expansion much easier.
A company heavily reliant on outdated technology can be a hidden cost waiting to happen.
Deal Feasibility: Will the Seller Accept a Fair Offer?
Before submitting an LOI, it’s crucial to gauge the seller’s expectations and motivation. Some sellers believe their business is worth its weight in gold – regardless of what the financials say. Ask:
- Seller’s Motivation – Why are they selling? Retirement, burnout, or financial distress all impact deal structure and urgency.
- Price Expectations – Are their expectations reasonable? If the asking price makes no sense compared to financials, negotiations may be an uphill battle.
- Flexible Deal Structures – Will they offer seller financing or an earnout? Flexibility can improve deal feasibility and reduce upfront risk.
A seller with unrealistic valuation expectations can lead to wasted time and frustration.
Red Flags That Should Give You Pause
- Financial inconsistencies – If the numbers don’t add up, proceed with extreme caution.
- High customer churn – Losing customers left and right? That’s a red flag.
- Unclear business processes – If nothing is documented, the transition will be painful.
- Unwillingness to discuss key deal terms – If a seller dodges important questions, there’s likely something they don’t want you to see.
Final Thoughts
Submitting an LOI is a significant step that signals serious intent. While it’s not a binding contract, it commits you to due diligence and can set negotiation expectations. By conducting thorough pre-LOI research, you minimize risks, avoid dead-end deals, and increase the likelihood of a successful acquisition.
Contact us today or book a free consultation and learn how we can be a trusted partner on your next deal!
