One benefit of running a marketplace is that we see both sides of the deal, and the gaps that surface long before an LOI is ever signed. Buyers come to pre-LOI diligence fixated on one question: is this business worth it? 

What they miss is that the seller is running diligence, too. Every question you ask, every offer you frame, every industry you chase tells the seller whether you're a credible buyer who'll actually close. 

Dylan Gans, co-founder of Baton, dug into this last week in a webinar with Peggy Fasano and Adam Markley from PROX Search Capital: two operators-turned-investors who've also sat on both sides. Here's what they shared about doing your due diligence while still making a great first impression.

Want to watch the full conversation? You can catch the recording here.

1. Stop treating the first conversation like a financial audit

One of the most common mistakes buyers make is showing up to the very first seller meeting with a spreadsheet's worth of questions. Why did accounts receivable dip in March 2024? What was your gross margin by product line in 2022?

The first thing you're there to do is build a relationship and understand what's made that company successful. These are small businesses, often built on relationships, a couple of key people, and the owner's sweat and reputation. Before you earn the right to dig into the financials, you need to earn some trust.

Save the granular financial questions for after you've had a substantive conversation. You'll get better answers anyway.

2. Under-diligence and over-diligence are both ways to lose

An LOI is a non-binding document, but it sets the tone for everything that follows. Submit one too early, with terms you can't finance or based on a business you don't fully understand, and you'll burn goodwill, waste the seller's time, and likely walk away a month in. Blast out LOIs across five businesses hoping something sticks, and any experienced broker will quietly deprioritize you.

Over-diligence before the LOI is also a trap. You're never going to get perfect information pre-LOI, and pushing for it signals either inexperience or distrust.

"You don't have to be perfect. The idea is can you get it within a reasonable margin of error to be confirmed in actual due diligence post-LOI?" — Adam Markley

What you want to validate before submitting: earnings are roughly what the seller claims, there are no massive red flags in the fundamentals, and you understand the major risks well enough to structure around them.

3. Watch the gap between stated earnings and bankable earnings

Accepting a seller's stated earnings number without pressure-testing the add-backs is one of the most common ways buyers get into trouble,

If a seller says they're making $1M in earnings but after normalizing add-backs the number comes to $800K, and you offered 4x on the stated $1M, that's a $4M offer. A bank underwrites that as a 5x deal on the adjusted number. That's a fundability problem, and it typically surfaces right when you least want it to.

The goal pre-LOI isn't to audit the books, but rather to get close enough that you're not blindsided. Ask about the owner's comp, whether rent is included, what the big add-backs are, and whether they're adjusting for occupancy costs.

Peggy shared a case from a deal she was working on: the seller also owned the property and hadn't been charging the business rent. No rent, no maintenance, nothing on the books. That was $250,000 missing from the add-backs entirely. Catch it pre-LOI and you adjust your offer. Miss it and you've overpaid before diligence even starts.

4. Gross margin volatility tells you more than EBITDA

Most buyers anchor on EBITDA. Adam's preferred early signal is gross margin, and specifically whether it's stable over time.

If gross margin bounces around year to year, that's a meaningful data point: the business lacks pricing control. Whatever their input costs are, labor, materials, cost of goods, they can't consistently pass increases through to customers. That's an operational problem that survives the acquisition.

"What are you buying? Are you buying a business with 40% gross margin or one with 50%? That 10% delta on a relative basis is 20-25% depending on which way you're looking." — Adam Markley

Once you're servicing acquisition debt, that spread matters enormously. And unlike revenue, which owners can juice with one strong year, gross margin consistency is hard to manufacture over a long period. A volatile gross margin line is a signal the business is reactive, not in control of its own economics.

5. Buyers optimize for what's possible. Underwrite what's probable.

Every buyer walks into a deal thinking about upside. What if I add a salesperson? Expand the territory? Land that enterprise client? Optimism is part of why people do this. But it becomes a problem when possibilities start substituting for probabilities in your underwriting.

"We're all designed to think about what's possible. But probabilities are saying what is the most likely outcome? What's more realistic?" - Adam Markley

This is where a lot of first-time buyers get hurt. The quality of earnings report comes back and their assumed $1M in profit is $700K. By that point, they've already mentally moved in. They've started imagining how they'll run the business, what they'll change, how the income will feel. Losing 30% of that number, and more than 30% of their fundability and renegotiation leverage, hits hard. And renegotiating a signed LOI is difficult. Whatever trust you've built, it's hard to bridge that gap without the deal dying.

Build your LOI around what the business has actually demonstrated. Growth assumptions belong in your investment thesis, not your purchase price.

6. Stress test the business before you sign

One pre-LOI exercise that most buyers skip entirely is a basic stress test of the business's debt service coverage ratio under a downside scenario.

The question isn't just whether the business can service the debt at current earnings. What happens if the top customer walks and takes 20% of revenue? What if you have to replace a major piece of equipment in month 12 that wasn't in the plan? 

SBA loans are typically 80-90% of the purchase price. That's a lot of debt, and it leaves very little room for the business to have a bad year. Running a quick downside scenario before you sign tells you whether the deal only works if everything goes right, which is useful information to have before you're the one on the personal guarantee.

This math doesn't need to be precise. A back-of-napkin DSCR model assuming 20% less revenue will tell you a lot about whether a deal is genuinely viable or just optimistically priced.

7. Understand the seller's "why" before you structure anything

About 60% of sellers care more about money than anything else, but 100% of sellers want to work with a buyer they trust.

Peggy broke down what understanding the seller means in practice:

• Why are they selling, and is the story consistent? If they say retirement but have no hobbies and no plan, that's a flag worth probing.

• How involved are they in the day-to-day? If they're doing engineering work, managing key relationships, or running the crew directly, the deal needs a substantive transition plan, not a 30-day handshake.

• Do they own key customer or vendor relationships? If yes, that has to show up in the deal structure.

• Can you see yourself working with this person for one to three years? Because you probably will be.

Understanding the seller's motivations also shapes what you offer. A seller who needs a big lump sum to buy a house and a seller who wants seller financing as a retirement annuity are two completely different deals. Knowing which one you're in lets you craft an offer they'll actually want to accept.

8. Every business has risk. Structure is how you manage it.

Finding a business with no risk is not the goal. Every small business has risk. The job pre-LOI is to identify the major ones and build a structure that accounts for them.

A few specific tools Peggy walked through:

High customer concentration? Use a contingent seller note tied to revenue from those customers. If the top client leaves and takes 20% of revenue, the note gets deferred or reduced. You're not servicing full debt on a business that just lost a fifth of its revenue.

Seller dependency? A defined consulting agreement in writing, five hours a week for 12 months or on-call availability for a set period, is much stronger than a verbal promise. A seller note also keeps them financially connected to the outcome.

Key employee risk? Build retention mechanics into the deal structure or price the uncertainty in directly. An earnout tied to employee or customer retention is a legitimate lever here.

"Every small business is going to have some level of risk. How do you take that risk and mitigate it so that if something happens post-acquisition, you're not completely out of luck?" — Peggy Fasano

The best LOIs reflect a thorough understanding of the business: its earnings, its seller, its risks, and how much stress it can actually handle.

9. Show your work when you make an offer

Show, don't tell. Walk the seller through your adjustments.

• Here's the earnings figure I'm working from.

• Here are the add-backs I accepted and the ones I didn't.

• Here's what two lenders said when I showed them the business.

• Here's why I landed at this number.

That transparency does three things. It demonstrates seriousness. It preempts the seller feeling lowballed without context. And it anchors the negotiation around logic, which means if the QoE comes back lower than expected, you already have the framework to renegotiate without blowing up the deal.

Adam also suggested building a multiple reference directly into the LOI: "We're assuming a 4x multiple to arrive at our purchase price. If due diligence proves earnings are different, we will adjust accordingly." If the number comes in lower, you're applying the same logic you already disclosed, not retrading.

10. Have a thesis before you start looking

Adam made a sharp observation about buyer credibility: if you're pursuing a plumbing company, a CPA firm, and a marketing agency at the same time, brokers notice. And they deprioritize you.

Buyers with a focused thesis come across as more credible, more believable, and more likely to close. They can articulate why they're the right person to run a specific business. Sellers want to hear that. Brokers want to see it.

"If you can't sell the product or service of the business you're buying, you probably shouldn't buy it." — Adam Markley

The one-degree-of-separation rule: look for businesses where at least one of your core competencies, whether that's sales, operations, people management, or a technical skill, maps directly onto what that company needs from a new owner. Everything else is a wish.

Final thoughts

Buying a small business is a process that requires genuine relationship-building, honest self-assessment, and a pragmatic view of risk. The buyers who succeed show up with credibility, build trust with the seller, understand the business well enough to structure a fair deal, and have the staying power to see it through diligence.

There are sellers on Baton ready to find the right buyer now. One NDA puts you in front of every one of them. See what's available at baton.com.