The Three Questions Every Search Funder Should Ask Before Signing an LOI
Most search fund entrepreneurs spend weeks modeling the upside. The ones who get burned skip three questions that take an afternoon to answer.
You found a business. The numbers work. The industry has tailwinds. The seller seems reasonable. Your investors are ready. Time to sign the LOI and lock it up, right?
Not yet. Not before you answer three questions that most first-time searchers never ask — and every experienced operator wishes they had.
1. "What happens if the two largest customers leave?"
Customer concentration is the most common deal killer in lower-middle-market acquisitions, and it's almost never disclosed in the listing. A business with $3.5M in revenue and $800K in cash flow looks great on paper. If 40% of that revenue comes from two customers — and one of them is the owner's golf buddy — you're buying a relationship, not a business.
Here's what to ask before the LOI:
- What percentage of revenue comes from the top 3 customers? Top 5?
- How long have those relationships existed? Are there contracts, or handshakes?
- Would any of those customers follow the owner if they left?
- What's the churn rate? When did the last major customer leave, and why?
Red flag: If the seller won't share an anonymized customer list pre-LOI, that's not standard caution — it's a signal. Every serious seller provides this. The ones who don't are hiding something.
2. "What am I actually buying — and what walks out the door with the owner?"
In businesses under $5M in revenue, the owner is often the sales department, the key account manager, the technical expert, and the person who knows which supplier to call when the resin shipment is late. You're not buying a machine. You're buying a set of relationships, processes, and institutional knowledge — and some of it lives entirely in one person's head.
This is especially acute in manufacturing, distribution, and B2B services — exactly the sectors search funders target. A fabrication shop where the owner personally manages the three largest accounts and holds the contractor's license is a different business than one where a general manager runs day-to-day operations and the owner shows up for board meetings.
Before the LOI, get specific:
- How many hours does the owner actually work? Not "whatever it takes" — a real number.
- What happens if they take a two-week vacation? Who handles what?
- Are there any licenses, certifications, or relationships that are personally held by the owner?
- What's the org chart below the owner? Is there a clear #2?
If the answer to the vacation question is "I don't take vacations," price that into your offer. A six-month transition period with the seller as a paid consultant is standard. A business that can't survive a two-week absence needs more than a transition — it needs a rebuild.
3. "What's the real EBITDA after I normalize for the owner?"
Seller's discretionary cash flow is not EBITDA. It's a number that includes the owner's salary, their spouse's "marketing consulting" fee, the truck they lease through the business, and the family vacation they expensed as a "client visit."
This is well-understood in theory and consistently underestimated in practice. We've seen deals where the "adjusted EBITDA" was $834K on paper and closer to $550K after normalizing for owner compensation, below-market rent, and maintenance capex the seller had been deferring.
Your normalization checklist:
- Owner compensation: What would it cost to hire a real general manager? Not what the owner currently takes — what the market rate is for someone who can actually run the business.
- Rent: If the seller owns the building and charges below-market rent, normalize to market. If the lease expires in 18 months, factor in the renewal.
- Maintenance capex: Every business has deferred maintenance. FRP fabrication equipment needs periodic replacement. Roofs leak. Forklifts break. Estimate $30K–$50K annually for a small manufacturer and see if the seller's numbers account for it.
- Personal expenses: The boat, the truck, the "marketing trips" to Vegas. Add them back to get SDE, then subtract the real cost of running the business.
Rule of thumb: If the seller's SDE-to-EBITDA bridge is less than $100K in adjustments, you're probably missing something. In businesses under $5M, normalized EBITDA typically runs 15–25% below stated SDE.
The LOI is not the finish line
Search fund entrepreneurs are under pressure to move fast. Deals get competitive. Investors want to see progress. The temptation to sign the LOI and "figure it out in diligence" is real.
But the LOI sets the anchor. If you sign at $3.5M and diligence reveals customer concentration that drops the real value to $2.5M, re-trading is painful — and sometimes impossible. The seller feels bait-and-switched. The broker gets defensive. The deal dies, and you've burned six weeks and your investors' patience.
Ask the three questions before the LOI. You don't need perfect answers — you need enough to know whether the deal is worth pursuing at the asking price. If the seller won't engage on these questions pre-LOI, that's your answer.
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