What Buyers Look for
in an Acquisition Target

Financial Performance and Quality of Earnings

Financial performance is usually the first thing a buyer or their advisors will examine, but it is rarely just a top-line revenue number. Buyers and private equity firms look closely at EBITDA trends over multiple years, not a single strong quarter, to understand whether performance is stable, improving, or masking underlying volatility. They also scrutinize add-backs and normalization adjustments, which are owner's discretionary expenses, one-time items, and non-recurring costs that get added back to arrive at adjusted EBITDA. Reasonable add-backs are normal in a lower middle market business sale, but aggressive or poorly documented ones tend to erode buyer trust quickly.

This is part of why a quality of earnings review, often conducted by an independent accounting firm during due diligence, has become such a common step in M&A. It exists to confirm that reported earnings reflect the true, sustainable economics of the business rather than accounting choices. Clean, consistent financial records (ideally reviewed or audited, and reconciled month to month) make this process faster and give buyers more confidence in the numbers they are underwriting a purchase price against.

What a Quality of Earnings Review Actually Tests

Owners often picture a quality of earnings review as an audit. It is not. An audit asks whether the statements comply with accounting rules. A quality of earnings review asks a blunter question: if I buy this business on Tuesday, how much cash will it actually generate on Wednesday, and which of these earnings walk out the door with the seller?

Four tests do most of the work, and each one has a predictable failure mode:

• Add-back substantiation. Every discretionary expense you add back needs a document behind it. A personal vehicle on the company books is defensible with a title and a mileage log. “Owner compensation above market” is defensible with a compensation study. A round number with no paper trail gets struck, and a pattern of struck add-backs makes the accountant re-examine the ones they had accepted.
• Revenue recognition and cutoff. The reviewer will test whether revenue landed in the period the work was performed. Businesses that invoice on milestones, bill annually in advance, or recognize a full contract at signing frequently discover their “growth” year was partly a timing shift.
• Run-rate versus trailing performance. A buyer paying a multiple of trailing twelve-month EBITDA wants to know whether the last three months look like the twelve. A strong recent quarter helps you only if it is explainable and repeatable; an unexplained one invites a discount for volatility.
• Working capital normalization. This is the test owners are least prepared for and it moves real money. See below.

Commissioning your own sell-side quality of earnings review before going to market costs money and finds problems you would rather not know about. That is the point. Finding them at your own pace is materially cheaper than finding them in week six of exclusivity, when the only available responses are a price reduction or a broken deal.

The Working Capital Peg, Explained Plainly

Nearly every lower middle market deal is done on a cash-free, debt-free basis with a normalized working capital target, usually called the peg. The buyer sets an expected level of receivables, inventory, and payables the business needs to run, and at closing your actual working capital is compared against it. Deliver less, and the purchase price is reduced dollar for dollar. Deliver more, and you are paid the difference.

Two things make this contentious. The first is that the peg is usually calculated as an average over the trailing twelve months, so a seasonal business can be measured against a target that does not reflect its closing-month reality. The second is that the calculation is negotiated late, when leverage has shifted to the buyer. Owners who collect aggressively and stretch payables in the months before closing sometimes find they have simply lowered their own peg and handed the benefit to the buyer.

This mechanism matters enough that buyers ring-fence it. In SRS Acquiom's study of more than 2,200 private-target acquisitions closed between 2019 and 2024, representing $505 billion in value, more than three-quarters of deals included a special-purpose escrow dedicated to the purchase price adjustment alone, separate from the general indemnity escrow (SRS Acquiom M&A Deal Terms Study). Ask for the peg calculation in writing at the letter of intent stage, not the purchase agreement stage.

Growth Trajectory and Market Position

Buyers are not just paying for what a business has already earned; they are paying, in part, for where it is headed. Organic growth trends matter more than growth driven entirely by acquisitions, price increases, or one-time contracts, because organic growth tends to signal a durable underlying demand for the product or service. A business with a multi-year track record of steady, explainable growth is generally viewed more favorably than one with an erratic pattern of spikes and declines.

Competitive positioning and differentiation also factor in. A buyer will typically want to understand why customers choose this business over alternatives, whether that is proprietary technology, a specialized niche, long-standing relationships, geographic advantages, or operational efficiency. A target that competes primarily on price, with little else to differentiate it, is usually viewed as more vulnerable to competitive pressure after a sale.

Customer and Revenue Concentration

Few issues raise buyer concern faster than heavy reliance on a small number of customers or contracts. If one customer represents a large share of revenue, the loss of that relationship after closing could materially affect the business, and buyers know this. As a general guideline, the more revenue that sits with a handful of accounts, the more a buyer may discount value or ask for structures like earnouts to share that risk.

Buyers also distinguish between recurring or repeatable revenue, such as subscriptions, service contracts, maintenance agreements, or a strong pattern of repeat purchases, and one-time or project-based revenue that must be re-won every cycle. Recurring revenue is generally viewed as lower risk because it is more predictable, and businesses with a higher share of it often command more buyer interest.

The Thresholds Buyers Actually Use

“Too much concentration” sounds subjective, and in the abstract it is. In practice the market has settled on rough bands, and they are worth knowing before a buyer applies them to you.

Ten percent is where concentration becomes a disclosed fact rather than an internal one. US accounting standards require a company to disclose revenue from any single external customer representing 10% or more of total revenue, so that threshold is baked into how financial professionals read a business. Above roughly 20%, most buyers treat a customer as material concentration and begin adjusting for it. Above roughly 30%, concentration typically stops being a valuation input and becomes a structural one: the response is an earnout, a larger holdback, or a requirement that the contract be reassigned and confirmed before closing.

Financing adds a second constraint owners rarely anticipate. A large share of lower middle market deals depend on lender approval, and lenders underwrite concentration more conservatively than buyers do. A deal a buyer is willing to price can still fail because the bank will not fund it, which is why concentration should be addressed as a financing problem and not only a valuation one.

Three qualifiers change the picture, and it is worth knowing which apply to you. Contracted revenue with multi-year terms and assignment provisions reads very differently from a large customer who buys at will. Concentration inside a business where every competitor has the same structure, such as a supplier to a consolidated industry, is priced as an industry characteristic rather than a company flaw. And a concentrated customer relationship held by the management team rather than by the departing owner survives the transition much more credibly. Have the answer to all three ready.

Owner Dependency and Management Depth

A recurring theme in lower middle market M&A is what advisors sometimes call "key person risk." Buyers want to understand how much the business relies on the founder personally, whether for sales relationships, technical expertise, vendor negotiations, or day-to-day decision-making. A business that cannot function without its owner in the room every day is inherently harder to underwrite, because the buyer is effectively betting on a transition that has not yet been tested.

Businesses with a management team capable of operating independently of the owner, even for a period of weeks, tend to be viewed as more transferable and lower risk. Buyers will also ask about succession readiness: is there a general manager, controller, or operations lead who could step up, and has the owner already begun delegating meaningful responsibility ahead of a sale process?

Operational and Legal Cleanliness

Beyond the financial and strategic picture, buyers pay close attention to how well-organized and low-risk the business is to operate and to acquire. This includes documented processes and standard operating procedures rather than knowledge that exists only in the owner's head, clean and assignable customer and vendor contracts, and up-to-date compliance with relevant licensing and regulatory requirements. Litigation history, whether pending, threatened, or resolved, is also reviewed closely, as is the state of employee and HR matters, including employment agreements, benefits administration, and any history of workplace disputes.

None of these items alone will make or break a deal, but unresolved issues in this category tend to slow down due diligence, invite additional buyer protections in the purchase agreement, or in some cases cause a buyer to walk away altogether.

What the Data Says About Being Ready

The payoff for clearing the items above is measurable. In the IBBA and M&A Source Market Pulse survey of completed transactions up to $50 million, 83% of deals above $5 million attracted at least three offers and 18% attracted ten or more (IBBA / M&A Source Market Pulse). Businesses that reach a competitive process do not usually get there by accident; they get there because the diligence questions above were answered before buyers asked.

The same survey shows the buyer field is broader than most owners assume: in the lower middle market, 35% of buyers were strategic acquirers, 19% private equity firms, and 24% first-time buyers. Each stress-tests a different thing. Strategics probe customer overlap and integration risk, private equity probes management depth and the durability of earnings, and first-time buyers probe whether the business runs without you and whether a lender will finance it. Owner dependency is the one weakness that costs you with all three.

How Buyers Turn Risk Into Structure

Owners tend to negotiate the headline number and accept the structure. Buyers know this, which is why unresolved risk usually reappears as terms rather than as a lower price. Here is the translation table.

The earnout line deserves emphasis because owners consistently overvalue it. Across SRS Acquiom's deal population, earnouts paid roughly 21 cents on the dollar of the amount at stake, excluding life sciences transactions, and 68% of deals with earnouts used more than one performance metric (SRS Acquiom). That sample skews to larger, well-lawyered transactions, so treat it as directional rather than a prediction for a $15 million deal. The direction is the point: an offer of “$18 million, with $4 million in earnout” is not an $18 million offer, and it should not be compared against a $16 million all-cash offer as though it were.

Escrow sizing follows a similar logic. That study found the median general indemnification escrow held steady at 10% of transaction value on deals without representation and warranty insurance, and just 0.5% where such insurance was in place. If your deal is large enough for an insured structure, the cash you take home at closing changes materially. Ask your advisor early whether your transaction is a candidate.

What Diligence Looks Like in Your Sector

The five factors above apply everywhere. What differs is which one a given buyer pool interrogates hardest, and that depends on your industry.

• Industrials and manufacturing. Expect scrutiny of equipment age and deferred maintenance, environmental exposure at owned sites, supplier concentration alongside customer concentration, and whether gross margin survives an input-cost swing. Our guide to M&A advisors for industrials and manufacturing covers the active buyers in that segment.
• Business services. Contract assignability, churn, and whether client relationships belong to the firm or to the founder personally tend to dominate. Buyers will ask to see revenue by client cohort over several years. See our guide to M&A advisors for business services companies.
• Early childhood education. Enrollment and utilization trends, licensing history, staff-to-child ratios, teacher retention, and lease or real estate control drive both the price and which buyers can transact at all. Our guide to M&A advisors for early childhood education maps that buyer field.
• Consolidating sectors. Where a roll-up is running, the acquirer has bought dozens of businesses like yours and has a standard playbook, a standard structure, and a standard set of things they intend to find. Our piece on roll-ups in legal services and pet care explains how that changes the negotiation.

How to Get Ahead of the Diligence

Owners who are thinking about a future sale, even years in advance, can generally take a few concrete steps to strengthen how a business will be perceived:

• Start preparation early. Many of the factors buyers care about, such as management depth and financial systems, take years, not months, to build.
• Address customer concentration before going to market. Diversifying the customer base ahead of a sale process is far easier than trying to explain concentration risk mid-diligence.
• Build out management bench strength. Identifying and developing a second layer of leadership reduces perceived owner dependency.
• Get financials review-ready. Clean, well-organized, and ideally reviewed financial statements make due diligence smoother and can support a more confident valuation conversation.

The Documents Buyers Will Ask For

You can predict most of the first diligence request list, because it barely changes from deal to deal. Assembling it before you go to market converts weeks of scramble into days, and speed protects deals: every extra week of diligence is another week for a buyer's circumstances, financing, or enthusiasm to change.

• Financial. Three years of financial statements plus a current year to date, monthly profit and loss detail, tax returns matching those statements, an accounts receivable aging, an accounts payable aging, and a fixed asset register.
• Revenue detail. Revenue by customer by year, revenue by product or service line, a pipeline or backlog schedule, and the top customer contracts themselves.
• People. An employee census with tenure, role, and compensation, an organization chart, employment and non-compete agreements, and a summary of benefit plans.
• Legal and operational. Entity formation documents and the cap table, leases, licenses and permits, insurance policies and claims history, any litigation past or pending, and material vendor agreements.

Two consistency checks are worth running yourself before a buyer runs them for you: your tax returns should reconcile to your financial statements with differences you can explain in a sentence each, and your revenue-by-customer schedule should tie to your income statement exactly. Discrepancies in either are the fastest way to turn a confirmatory diligence process into an investigative one.

It All Comes Down to Risk

Buyers are trying to answer one question: how much risk does this business carry, and how much of that risk will persist after closing? Financial quality, growth, customer diversification, management depth, and operational cleanliness are the lenses buyers use to answer that question. Owners who understand these factors ahead of time are generally in a stronger position when a sale process eventually begins.