Key Takeaways
- Due diligence is where deals are tested. After the LOI is signed, buyers move beyond assumptions and closely examine the company's financial performance, operations, and risk profile to validate the value of the business.
- Most transaction issues stem from risks that existed before the sale process began. EBITDA adjustments, working capital disputes, customer concentration, and Quality of Earnings findings can impact valuation and deal terms when they are not identified and addressed early.
- Preparation is one of the most effective ways to protect deal value. Proactively evaluating potential concerns through sell-side due diligence can reduce surprises, strengthen credibility with buyers, and help keep the transaction on track through closing.
For many privately held business owners going through a transaction, signing a Letter of Intent (LOI) may feel like the hard part is over. However, in our experience, the period between the LOI and the actual closing is where deals are tested, and where many could fall apart. The reason is simple: the story gets replaced by data. Buyers stop relying on high-level assumptions and start validating every detail of the business.
During the due diligence phase expectations are pressure-tested, financials are normalized, risks are quantified, and assumptions are challenged. When gaps show up between what was expected at LOI and what is proven in diligence, value changes, or the deal is at risk.
Below are the most common reasons we see deals break down during this stage.
EBITDA Adjustments
Missed Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) expectations are the number one issue.
At LOI, valuation is typically based on a version of adjusted EBITDA that includes addbacks and normalization assumptions. During due diligence, buyers re-evaluate the business using detailed financial data. If revenue is inconsistent, margins fluctuate more than expected, or addbacks can’t be supported, EBITDA may be reduced. And when EBITDA moves, the purchase may also change. This could lead to a price reduction, change in consideration type, or even a breakdown in negotiations if expectations are too far apart.
Unclear or unsupported expense addbacks are another common problem. Most privately held businesses include adjustments to EBITDA for non-recurring or personal expenses. These are expected by a buyer. However, issues can arise when these adjustments aren’t clearly documented or are overly aggressive. Buyers expect to see a clean and defensible bridge from reported EBITDA to adjusted EBITDA. If they can’t follow the logic or verify the adjustments, they’ll remove or reduce them. This not only impacts value but can also damage trust in the process.
Net Working Capital
Working capital misunderstandings are another frequent source of friction. Details on net working capital are often unclear in the LOI stage. Differences in assumptions around accounts receivable, inventory levels, or timing of expenses can create issues late in the process.
When buyers analyze working capital based on historical data, they may determine that the business requires more capital to operate than originally assumed. This directly impacts the cash the seller receives at closing and can create last-minute tension.
Customer Concentration
Customer concentration is another issue that surfaces quickly during due diligence. While many business owners are aware of their key customers, the risk is often understated or not fully analyzed before LOI.
Buyers look closely at how much revenue is tied to a small number of clients. If a significant portion of revenue depends on one or two relationships, it raises concerns about sustainability. Lenders may also hesitate to support the deal if this risk is too high. Even if the business is performing well, the risk associated with a key customer can lead to buyer trepidation and valuation concerns.
Quality of Earnings Findings
Quality of Earnings (QoE) issues often emerge during due diligence and can quickly change a buyer's perspective on value. While a business may appear to be performing well on the surface, buyers look beyond reported earnings to understand what is truly sustainable. They evaluate whether revenue is recurring, margins are consistent, and earnings are supported by normal business operations.
If due diligence uncovers one-time revenue, unusual customer purchasing patterns, margin compression, or other factors that make earnings less predictable, buyers may adjust their valuation or seek additional protections in the purchase agreement. These findings don't necessarily derail a transaction, but they can significantly impact negotiations if they come as a surprise.
Preparation Reduces Risk
The key pattern across all these issues is that they’re rarely new problems. They’re usually issues that existed before the LOI but weren’t fully analyzed or disclosed up front. Due diligence doesn’t create problems; it reveals them. By the time they’re discovered, there is often less flexibility to address them, and emotions are higher on both sides.
For business owners, there is a clear takeaway: preparation matters more than negotiation. The most successful transactions aren’t the ones without issues, but the ones where issues are understood early, clearly communicated, and supported with data.
Performing sell-side financial due diligence prior to going to market is an excellent way to stay in front of issues. In particular, using an advisor who’s also familiar with the buyer’s mindset can provide additional insight into potential roadblocks.
Getting to the LOI stage of a transaction is about telling a compelling story. Getting to the deal close is about proving it. The closer those two are aligned, the smoother the process and the better the outcome.
Strengthening Your Transaction Readiness
Proactive preparation can help you avoid surprises, maintain credibility with buyers, and protect value throughout the transaction process. Engaging experienced advisors early allows you to identify potential issues, strengthen your financial narrative, and move through the due diligence process with confidence.
If you’d like to learn more about how Kreischer Miller can assist you with preparing your business for a transaction, please visit our M&A/Transaction Advisory page or contact us.