Deal diligence when buying a small business: what to check before the LOI

Deal diligence, for a small business buyer, is the check you run on the seller's numbers before you price the letter of intent (LOI), the written offer that sets the price before the final contract. The question it answers is whether the earnings figure the broker is showing you holds up against the seller's own tax returns.

Run it before the LOI. Once the LOI is signed, the price is anchored and the seller's patience is finite. Before it, the tax returns are enough to see whether the broker's number holds, and the price can still move.

Start with the tax returns, not the P&L

The tax return is the one set of numbers the seller signed under penalty of perjury. The P&L and the CIM are the seller's presentation of the business. Neither carries that signature.

Ask for two things:

• The last three years of business tax returns: Form 1120-S, 1120, 1065 or Schedule C, whichever the business files.
• The broker's add-back schedule, or the SDE calculation behind the figure in the listing.

SDE is seller's discretionary earnings: the yearly profit available to one owner-operator before that owner's pay. An add-back is a cost the broker adds to the return's profit on the theory that a new owner would not pay it. The return gives you the starting line. The broker's schedule shows what was added to it.

Three questions the returns answer before the LOI

An add-back with no line behind it is a question for the broker, not a number to carry forward.

A worked example

Harrow Creek Mechanical is a fictional HVAC company built to show the check. Here are its two most recent years.

In both years the number goes down. The broker's figure comes down to what the returns support, and the gap is listed line by line, so each item is a specific question for the seller before you commit to a price.

What waits until after the LOI

Some checks need documents the seller will not hand over before there is a signed letter of intent. Drawing the line there keeps the early check cheap for both sides.

Already past the LOI? This is the next step, and where add-backs that held on the returns can still fail against the bank statements. Probity's Cash Proof runs that tie-out and returns results within two hours of the last statement upload.

SBA buyers

SOP 50 10 8.1 took effect October 1, 2026. Every SBA change-of-ownership loan is sized by a coverage test on the business's earnings, and at $3 million or more, on a first-time purchase or one company buying another, the lender orders a Quality of Earnings report with a Cash Proof. The returns check does not replace that report. You run it first, so you know where the earnings stand before the lender's number arrives. The rules are laid out in the SBA guide for buyers. Paying cash with no lender? No lender test applies, so the returns check is the only one, and it is yours to run.

How Probity fits

Probity deal diligence runs this check from the returns in minutes: the SDE Recast, the bridge to the broker's number, and the findings, with every figure linked to its page. The free account runs it on one business of your own.

Probity is not a quality of earnings report, not an audit, and not an opinion of value.

Questions

What is deal diligence? It is the check a small business buyer runs on the seller's numbers. Before the LOI it works from the seller's business tax returns and the broker's add-back schedule, to see whether the broker's earnings figure holds. After the LOI it adds bank statements, customer data, inventory and interviews.

What documents do I need before the LOI? The seller's last three years of business tax returns (Form 1120-S, 1120, 1065 or Schedule C) and the broker's SDE or add-back schedule. Bank statements come after the LOI.

Which add-backs usually hold up? Owner salary, interest, depreciation and documented one-time items usually hold up when the return shows them. Rent the business will keep paying, personal vehicles, an item counted twice and anything not itemized usually come off.

Do I need a quality of earnings report under $3 million? The SBA requires one at $3 million or more on a first-time purchase or business expansion. Under that, the lender's coverage test still applies, and many buyers run the returns check themselves. Paying cash with no lender? No lender test applies, so the returns check is yours to run. Confirm with your lender.