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A lot of first-time buyers treat diligence like something that starts after the LOI.

I think that's backwards.

By the time you sign, you're probably emotionally committed, the seller has stopped talking to other buyers, the broker is pushing momentum, and you're about to spend real money on QoE, legal, lender work, and deal docs. That's a bad time to find out the deal had obvious problems from day one.

I'm not saying you need a full diligence process before LOI. You usually won't have enough information for that anyway. But you should absolutely run a pre-LOI sanity check before you start spending serious money.

Here are the five things I'd want to know before signing anything:

1. What is the real SDE after pressure-testing add-backs?

Seller says the business does $400k in SDE. Great. But what's inside that number?

If $80k is an "owner salary add-back," you need to ask whether someone has to replace that owner. If yes, what does that cost? If $50k is "one-time consulting" but it shows up every year, that's not one time. If $30k is "personal expenses" with no documentation, I'm not giving it full credit.

Here's why this matters:

• Asking price: $1.2M
• Stated SDE: $400k
• Implied multiple: 3.0x  (which looks reasonable)

But if $80k of add-backs don't hold up, your real SDE is closer to $320k. Now the same $1.2M ask is 3.75x. That's a very different conversation, and you want to have it before you begin signing anything.

2. Does the debt still work if SDE gets a haircut?

A lot of buyers model the deal on the seller's best-case SDE. That's dangerous.

If you're using SBA financing or any real leverage, you should model at least three scenarios before LOI:

• Seller-stated SDE
• 10% haircut
• 20% haircut

Then look at DSCR in each case. A deal showing 1.45x DSCR on stated SDE might drop to 1.16x after a 20% haircut. That's where lenders get uncomfortable and buyers start renegotiating late in the process. You want to know that before LOI, not after you've spent $15k to confirm it.

If the deal only makes sense at the seller's cleanest number, it probably doesn't work for you.

3. Is customer concentration hiding inside the revenue?

This one kills deals quietly.

Revenue looks stable, margins look good, and the multiple looks fair. You then get the customer details and find that one customer accounts for 35% of revenue, has no contract, and has been buying because they're friends with the seller.

That's not just a diligence note. It changes the valuation, structure, seller note terms, transition risk, and sometimes whether the deal is even financeable at all.

Before LOI I'd at least ask:

• How many customers make up the top 50% of revenue?
• Is any single customer over 20%?
• Are there contracts in place?
• How much of the relationship sits with the owner personally?
• What happens to DSCR if the top customer walks?

You may not get perfect answers pre-LOI, but if the broker won't even discuss concentration, then that alone tells you something worth knowing.

4. What working capital is actually included?

This is easily one of the most common ways buyers overpay without realizing it.

Purchase price is not the whole deal. I like to explain it to my buy-side clients using an example: if the seller plans to pull out $150k in AR and cash before close, and you need that to fund payroll and materials in the first 60 days, you didn't buy a $1.2M business. You bought a $1.35M business and found out after you signed.

Here are some questions I'd ask early:

• What cash stays in the business?
• What AR and inventory are included?
• What AP and accrued expenses come with it?
• Is there a working capital peg and a true-up mechanism?

If the answer is "we'll figure that out later," that usually means the buyer and seller are making very different assumptions, and that gets expensive fast.

5. What is the deal actually worth under a realistic structure?

Most buyers focus on the headline multiple. But structure matters just as much as price.

Here's another simple example to help: two buyers both offer $1M. One gets a deal with no seller note,  a thin DSCR, and no working capital protection. The other negotiates a $150k seller note, a 90-day working capital true-up, and a holdback tied to the top customer staying. Same price. Completely different deals.

Before LOI I'd want a rough view of:

• Senior debt amount and estimated payments
• Buyer equity required
• Seller note size and terms
• Any earn-out or holdback and what it's tied to
• Working capital requirement beyond purchase price
• DSCR under base and downside cases

You don't need a 40-tab model, but you do need enough structure to avoid making a dumb offer.

The simple pre-LOI checklist

In summary, before signing an LOI, I'd want to be able to answer these five questions:

1. What is stated SDE, and what does it become after haircutting weak add-backs?
2. Does DSCR still work at 10% and 20% lower SDE?
3. Is any customer concentration large enough to change the deal?
4. What working capital is included, and what will I need to fund separately?
5. Is the proposed price reasonable under the actual structure, not just the headline multiple?

If you can't answer those five, you may not be ready for an LOI yet. Not because the deal is bad, but because you don't know what deal you're actually offering on.

The best buyers I've seen aren't the ones with the fanciest models. They're the ones who slow down just enough before LOI to catch the obvious stuff. That boring pre-LOI work actually saves you a lot of money.

What's the one thing you wish you had caught before signing your LOI? And did you end up closing the deal anyway, or did it blow up?

One of the most consistently misunderstood things I see first-time buyers get steamrolled on is deal structure, specifically whether you're buying the assets of the business or the stock/membership interest.

Brokers gloss over it. Sellers definitely don't volunteer the information. And most posts I've seen here either say "consult a CPA" (not helpful) or give a two-sentence answer that doesn't actually explain the math. Having spent years in buy-side M&A, private equity, and corporate underwriting, here is the exact breakdown of how this structural choice completely shifts the economics of a transaction.

Why you almost always want an asset deal as a buyer

When you buy assets, you get what's called a step-up in basis. That means the purchase price gets allocated across the assets you're acquiring (equipment, inventory, furniture, goodwill, non-compete agreements) and you get to depreciate those from the new, higher value going forward.

Simple example: You buy a landscaping company for $500K. The seller's equipment on their books is fully depreciated (worth $0 to them). You allocate $150K of your purchase price to that equipment. Now you're depreciating $150K over 5–7 years. If we assume 5 years for simplicity, that's $30K of depreciation expense per year that you get to take against business income until fully depreciated. That's real tax shield, starting year one.  

In a stock deal, you get none of that. You inherit the seller's old depreciation schedule. The equipment is still worth $0 on the books, and you get $0 depreciation expense to offset business income.

To put some numbers on it, as the buyer in an asset deal, you’re getting $150K of new depreciable basis. If your marginal tax rate is ~37%, that's up to ~$55K of tax savings over the life of that depreciation just from this one allocation decision alone. In a stock deal, that same $150K of basis doesn’t exist for you, but the seller keeps more of the after‑tax proceeds because they avoid ordinary income rates on depreciation recapture.

Why the seller pushes for stock

Because their tax bill is dramatically lower.

In a stock deal, the seller pays long-term capital gains on the entire sale, usually 15–20% federal. Clean, simple, one tax event.

In an asset deal, the IRS breaks the sale into pieces. The allocation matters enormously here. If you load up the purchase price on equipment, the seller pays ordinary income rates on the depreciation recapture, potentially 37% on that chunk. Goodwill gets capital gains treatment, but other categories don't.

So when a seller says "I need it to be a stock deal," what they're really saying is: "I don't want to pay an extra $30–60K in taxes." That's their problem, not yours, but it becomes your problem if you concede it without negotiating a price adjustment.

The bridge: 338(h)(10) elections

If you're buying an S-corp (very common in SMB), there's a tax election called a 338(h)(10) that lets both parties treat the deal as an asset sale for tax purposes while keeping the legal structure of a stock sale. Both sides have to agree to it, and the seller typically needs a price bump to offset their higher tax hit, but it's a real tool worth knowing about.

Not available for every structure (doesn't work cleanly for C-corps or LLCs taxed as partnerships), but if you're looking at an S-Corp and the seller won't budge on stock deal, this is worth bringing to the table.

The allocation fight nobody warns you about

Even when both sides agree to an asset deal, the allocation of purchase price is its own negotiation. The IRS requires both parties to file consistent allocations (Form 8594), and how you split the number across asset classes affects both of your tax outcomes.

As a buyer, you want to allocate as much as possible to:
- Equipment / FF&E (fast depreciation, bonus depreciation still available)
- Non-compete agreements (amortized over 15 years, but deductible)
- Working capital assets (step-up carries through)

You also want to minimize allocation to goodwill, not because goodwill is bad, but because equipment depreciates faster and creates more near-term cash tax savings.

The seller wants the opposite. They want maximum goodwill to hit that low capital gains rate and minimum equipment allocation to avoid depreciation recapture. This is a real tug-of-war, and many first-time buyers don't even realize it's happening until they're deep in exclusivity.

Note to the current business owners in the sub: If you are planning to sell your business in the next few years, do not wait until you receive an LOI to look at this. If you blindly accept a headline purchase price without anchoring it to a stock sale or negotiating a tax-gapped price adjustment on an asset sale, you risk writing a massive, unexpected check to the IRS at closing.

Takeaway

Before you sign any paperwork, know what entity type you're dealing with and get an experienced M&A CPA in the room. Not just for formal due diligence, but to model the real after-tax numbers under both structures. A deal that looks like a great price on paper can easily cost you an extra $40–80K over 5 years just based on how those asset classes are split.

The reality is that purchase price allocation is a zero-sum game. Every dollar allocated to equipment protects the buyer's future cash flow but triggers immediate taxes for the seller. Because neither side models the actual after-tax walkaway proceeds pre-LOI, this is where deals frequently hit a total deadlock late in the game.

I’m curious to hear from both sides of the table in this community: If you're an active searcher currently trying to buy: What structure is the broker pushing, and have you modeled the tax step-up value yet?

• If you're an owner mapping out your eventual exit timeline: Have you actually calculated your true after-tax walkaway number under an asset sale vs. a stock sale?

These rules and recapture thresholds shift drastically depending on your industry and equipment density (for example, a fleet-heavy service or contracting company faces a completely different tax environment than a digital agency or B2B firm).

If you’re looking at a live deal right now or prepping your business for the market, drop your industry vertical and rough asset base in the comments below. I'm happy to give you a macro look at how buy-side lenders and standard tax structures typically allocate asset classes for that specific sector.

Many of the first‑time buyers I talk to think that the SBA works like this: you put 10% down, the bank covers 90%, and that’s it. In reality there are a few moving parts that can quietly blow up your deal or change how much cash you really need.

Here’s my easy-to-read version that I wish more buyers heard up front.

1. The “10% down” thing is real, but it’s not always your cash.
   The SBA wants at least 10% equity in the deal. On a straight acquisition, at least 5% of this has to be your money, and up to 5% can come from a seller note in the right structure. So on a $1M deal, you might get in with $50k of your own cash and a $50k seller note covering the rest of the injection.

The catch here is that the seller note has to be on “full standby.” That means the seller gets no principal and no interest payments until the SBA loan is completely paid off, which is usually 10 years. A lot of sellers hear that and say absolutely not, so don’t assume that the 5% from seller piece is easy. It is important to note here that the full standby only applies to the portion of the seller note being used to satisfy the equity injection.

2. The rules have changed and some people are still playing by the old ones.
   A couple of years ago seller notes only had to sit on standby for 24 months. Now if the note is counting towards the equity injection, it needs to be on full standby for the whole loan term. That’s a big shift, so if a broker is pointing to old deal structures they did back in 2022–2023, you want to make sure your lender is actually ok with what’s being proposed today.

3. DSCR is the number that really decides if you close or not.
   Debt Service Coverage Ratio (DSCR) is just a fancy way of saying how many dollars of cash flow do you have for every dollar of loan payment. Take the business’s cash flow, divide it by your annual SBA payment, and that’s your DSCR. The SBA’s floor is about 1.15, most lenders want to see around 1.25, and if you’re at 1.5 or above you’re usually in a much better spot.

It is important to note here that the bank will subtract an "Owner’s Draw" or "Living Expense" from the cash flow before they calculate that 1.25 ratio. So think EBITA (or a version of SDE) after this reasonable living allowance from a lender perspective.

Where people get burned is on the add‑backs. The CIM might show a beautiful SDE number, but the lender doesn’t have to accept every adjustment. If the bank knocks out a few of the “creative” add‑backs, your DSCR can fall under the line and the deal just dies after you’ve already spent your time and money.

4. Life Insurance Requirement.
   Most SBA lenders require a collateral assignment of a life insurance policy for the principal owner. It’s a small detail, but it’s a classic hidden cost and hurdle.

5. Personal guarantees actually mean personal.
   If you own 20% or more of the business, you’re personally guaranteeing the SBA loan. That usually means your house and personal assets are on the hook, not just the business. That doesn’t mean SBA is bad, it just means you should treat the leverage seriously and not stretch to the edge of what you can barely afford.

I’ve been asked by some of my clients in the past if they could use an LLC to acquire the business and shield their personal assets from this guarantee. When you use an LLC to acquire a business, the LLC is technically the primary borrower. In a standard scenario, this would protect your personal assets from the business's creditors. However, by signing the guarantee, you are waiving the limited liability protection specifically for that debt. 

If the LLC then defaults, the lender goes after the LLC’s assets first. If those are insufficient, the personal guarantee allows them to pivot directly to your personal bank accounts, investments, and in many cases, even take a lien on your home if you have sufficient equity.

An example I like to use is to think of the Personal Guarantee as a Backdoor to your personal bank account. The LLC is the front door, as it stops vendors and customers. But the SBA guarantee lets the bank walk right through the back door and grab your personal assets if the business can't pay.

Bottom line.
The SBA is an amazing tool for buying a small business, but it rewards people who understand the basics before they start sending LOIs around. Thin DSCR, aggressive add‑backs, or a seller who hates standby notes aren’t just negotiation headaches, but they’re the very things that can kill your deal late in the process.

If anyone has SBA issues they’re running into, or have related questions, just comment below and I’ll respond.

Many of the first‑time buyers I talk to think that the SBA works like this: you put 10% down, the bank covers 90%, and that’s it. In reality there are a few moving parts that can quietly blow up your deal or change how much cash you really need.

Here’s my easy-to-read version that I wish more buyers heard up front.

1. The “10% down” thing is real, but it’s not always your cash.
The SBA wants at least 10% equity in the deal. On a straight acquisition, at least 5% of this has to be your money, and up to 5% can come from a seller note in the right structure. So on a $1M deal, you might get in with $50k of your own cash and a $50k seller note covering the rest of the injection.

The catch here is that the seller note has to be on “full standby.” That means the seller gets no principal and no interest payments until the SBA loan is completely paid off, which is usually 10 years. A lot of sellers hear that and say absolutely not, so don’t assume that the 5% from seller piece is easy. It is important to note here that the full standby only applies to the portion of the seller note being used to satisfy the equity injection.

2. The rules have changed and some people are still playing by the old ones.
A couple of years ago seller notes only had to sit on standby for 24 months. Now if the note is counting towards the equity injection, it needs to be on full standby for the whole loan term. That’s a big shift, so if a broker is pointing to old deal structures they did back in 2022–2023, you want to make sure your lender is actually ok with what’s being proposed today.

3. DSCR is the number that really decides if you close or not.
Debt Service Coverage Ratio (DSCR) is just a fancy way of saying how many dollars of cash flow do you have for every dollar of loan payment. Take the business’s cash flow, divide it by your annual SBA payment, and that’s your DSCR. The SBA’s floor is about 1.15, most lenders want to see around 1.25, and if you’re at 1.5 or above you’re usually in a much better spot.

It is important to note here that the bank will subtract an "Owner’s Draw" or "Living Expense" from the cash flow before they calculate that 1.25 ratio. So think EBITA (or a version of SDE) after this reasonable living allowance from a lender perspective.

Where people get burned is on the add‑backs. The CIM might show a beautiful SDE number, but the lender doesn’t have to accept every adjustment. If the bank knocks out a few of the “creative” add‑backs, your DSCR can fall under the line and the deal just dies after you’ve already spent your time and money.

4. Life Insurance Requirement.
Most SBA lenders require a collateral assignment of a life insurance policy for the principal owner. It’s a small detail, but it’s a classic hidden cost and hurdle.

5. Personal guarantees actually mean personal.
If you own 20% or more of the business, you’re personally guaranteeing the SBA loan. That usually means your house and personal assets are on the hook, not just the business. That doesn’t mean SBA is bad, it just means you should treat the leverage seriously and not stretch to the edge of what you can barely afford.

I’ve been asked by some of my clients in the past if they could use an LLC to acquire the business and shield their personal assets from this guarantee. When you use an LLC to acquire a business, the LLC is technically the primary borrower. In a standard scenario, this would protect your personal assets from the business's creditors. However, by signing the guarantee, you are waiving the limited liability protection specifically for that debt. 

If the LLC then defaults, the lender goes after the LLC’s assets first. If those are insufficient, the personal guarantee allows them to pivot directly to your personal bank accounts, investments, and in many cases, even take a lien on your home if you have sufficient equity.

An example I like to use is to think of the Personal Guarantee as a Backdoor to your personal bank account. The LLC is the front door, as it stops vendors and customers. But the SBA guarantee lets the bank walk right through the back door and grab your personal assets if the business can't pay.

Bottom line.
The SBA is an amazing tool for buying a small business, but it rewards people who understand the basics before they start sending LOIs around. Thin DSCR, aggressive add‑backs, or a seller who hates standby notes aren’t just negotiation headaches, but they’re the very things that can kill your deal late in the process.

If anyone has SBA issues they’re running into, or have related questions, just comment below and I’ll respond.

One thing I see first-time buyers consistently underestimate is working capital. Everyone obsesses over the multiple and purchase price, but the thing that actually keeps the lights on after closing is how much “fuel in the tank” you’re getting with the business.

Most CIMs I see have pages on add-backs with almost nothing on the working capital peg, how it’s calculated, or how the post-close true-up works. That’s where buyers quietly overpay.

What “working capital” really is in SMB land

In plain English, think of working capital as the day-to-day operating cushion you’re buying:

- Accounts receivable 
- Inventory 
- Less accounts payable and accrued expenses 

Cash, long-term debt, and income taxes are usually carved out separately. You’re buying enough AR + inventory – AP to keep the business running without immediately having to write another big check after you close.

If you don’t define that clearly, you’re basically trusting that the seller leaves “enough” in the business.

A simple example of how buyers get clipped

Say you’re buying a contractor for $500K.

- The business is seasonal. Busy from April–September, slow in the winter. 
- The seller brings it to market and you close in February, when AR and inventory are both low. 
- The purchase agreement basically says “customary levels of working capital” without a real definition or target.

You close, start ramping into the busy season, and suddenly realize you need an extra $75K–$100K to fund materials and float receivables before cash actually comes in.

There’s no purchase price adjustment, no true-up. So in practice, you didn’t just pay $500K, you paid $500K + the extra $75K–$100K you had to inject after close, because working capital wasn’t properly pegged.

Same headline deal, very different effective price for the buyer.

What good looks like (from a buyer’s perspective)

On a clean deal, the purchase agreement will usually:

- Define a specific working capital target (often a 12‑month average, adjusted for one-offs and seasonality). 
- Spell out exactly which accounts are included and excluded (AR, inventory, AP, accrued expenses, etc.). 
- Specify how the post-close true-up works, for example in a period 60–90 days after close, the actual working capital at closing is compared to the target and the price is adjusted up or down dollar‑for‑dollar.

That maybe sounds a bit technical, but the principle is simple: you’re paying for a business that comes with a “normal” level of fuel, not one that’s been run on fumes to dress up cash flow before the sale.

Quick checklist for buyers

Before you sign an LOI or purchase agreement, ask yourself:

- What’s the working capital target, in dollars, and how was it calculated? 
- Does that target make sense given seasonality and how cash actually moves through this business? 
- Is there a band or range (like ±5%) where no adjustment is made? If so, how many real dollars does that represent? 
- After modeling out your first 12–24 months post-close, how much additional cash will you realistically have to put in on top of the purchase price?

A deal that looks like $500K on paper can very easily behave like a $600K+ deal once you factor in the working capital you have to inject because it wasn’t properly negotiated up front.

Has anyone here had a post‑closing surprise on working capital? Either a true-up you didn’t expect, or realizing six months in that you essentially bought a business that was under-fueled. What happened, and how did you handle it? 

I come from a Big 4 (EY) and Private Equity (Morgan Stanley) background and have helped clients buy and sell small businesses for years. One of the most consistently misunderstood things I see first-time buyers get steamrolled on is deal structure, specifically whether you're buying the assets of the business or the stock/membership interest.

Brokers gloss over it. Sellers definitely don't volunteer the information. And most posts I've seen here either say "consult a CPA" (not helpful) or give a two-sentence answer that doesn't actually explain the math. So here's what you need to know:

Why you almost always want an asset deal as a buyer

When you buy assets, you get what's called a step-up in basis. That means the purchase price gets allocated across the assets you're acquiring (equipment, inventory, furniture, goodwill, non-compete agreements) and you depreciate those from the new (higher) value going forward.

Simple example: You buy a landscaping company for $500K. The seller's equipment on their books is fully depreciated (worth $0 to them). You allocate $150K of your purchase price to that equipment. Now you're depreciating $150K over 5–7 years. If we assume 5 years for simplicity, that's $30K of depreciation expense per year that you get to take against business income (so roughly $30K of income that’s sheltered from tax each year for 5 years). That's real tax shield, starting year one.  

In a stock deal, you get none of that. You inherit the seller's old depreciation schedule. The equipment is still worth $0 on the books, and you get $0 depreciation expense to offset business income. You paid $500K for the business and get almost no deductible basis from it.

To put some numbers on it, as the buyer in an asset deal, you’re getting $150K of new depreciable basis. If your marginal tax rate is ~37%, that's up to ~$55K of tax savings over the life of that depreciation just from this one allocation decision alone. In a stock deal, that same $150K of basis doesn’t exist for you, but the seller keeps more of the after‑tax proceeds because they avoid ordinary income rates on depreciation recapture.

Why the seller pushes for stock

Because their tax bill is dramatically lower.

In a stock deal, the seller pays long-term capital gains on the entire sale, usually 15–20% federal. Clean, simple, one tax event.

In an asset deal, the IRS breaks the sale into pieces. The allocation matters enormously here. If you load up the purchase price on equipment, the seller pays ordinary income rates on the depreciation recapture, potentially 37% on that chunk. Goodwill gets capital gains treatment, but other categories don't.

So when a seller says "I need it to be a stock deal," what they're really saying is: "I don't want to pay an extra $30–60K in taxes." That's their problem, not yours, but it becomes your problem if you concede it without negotiating a price adjustment.

The bridge: 338(h)(10) elections

If you're buying an S-corp (very common in SMB), there's a tax election called a 338(h)(10) that lets both parties treat the deal as an asset sale for tax purposes while keeping the legal structure of a stock sale. Both sides have to agree to it, and the seller typically needs a price bump to offset their higher tax hit, but it's a real tool worth knowing about.

Not available for every structure (doesn't work cleanly for C-corps or LLCs taxed as partnerships), but if you're looking at an S-corp and the seller won't budge on stock deal, this is worth bringing to the table.

The allocation fight nobody warns you about

Even when both sides agree to an asset deal, the allocation of purchase price is its own negotiation. The IRS requires both parties to file consistent allocations (Form 8594), and how you split the number across asset classes affects both of your tax outcomes.

As a buyer, you want to allocate as much as possible to:
- Equipment / FF&E (fast depreciation, bonus depreciation still available)
- Non-compete agreements (amortized over 15 years, but deductible)
- Working capital assets (step-up carries through)

You also want to minimize allocation to goodwill, not because goodwill is bad, but because equipment depreciates faster and creates more near-term cash tax savings.

The seller wants the opposite. This is a real negotiation and most buyers don't even know it's happening.

Takeaway

Before you get anywhere near LOI, know what entity type you're buying and get your CPA in the room. Not just for due diligence, but to model the after-tax purchase price under both structures. A deal that looks like $500K can cost you an extra $40–80K over 5 years depending on how you structure it.

Has anyone run into issues here, successfully negotiated a 338(h)(10) election, or had a seller dig in hard on stock deal? What did you end up doing?

Feel free to drop questions below, as I’m happy to clarify anything.