What to Check Before Signing an LOI: The Pre-LOI Screening Framework

Key takeaways

• Pre-LOI work is the cheapest part of a deal. Walking from a deal mid-diligence costs $25K-$75K. The pre-LOI screen costs nothing but the buyer's time.
• Four pillars cover the deal-killer surface area: SDE normalization, comp discipline, SBA fundability, operator transferability.
• Lender-grade SDE typically runs 5-15% below broker-presented SDE after market-rate owner replacement and Tier 3 add-backs are removed.
• Industry multiple bands matter: services 2.5-4x, light manufacturing 3-5x, recurring revenue 4-7x. A deal priced 50% above its band needs a real justification.
• SBA DSCR floor is approximately 1.15x — and the lender models its own SDE, not the broker's headline number. A 1.4x headline DSCR often underwrites to 1.1x or below.
• Customer concentration above 15% per customer or 50% top-three is structural risk that needs to be quantified pre-LOI.
• The full screen takes 1-2 weeks for a well-prepared broker file and produces one of three outcomes: ready for LOI, modified structure, or killed.

Why the LOI is the inflection point

Signing a letter of intent commits the buyer to three things: diligence expense, exclusivity (typically 30-90 days), and a price anchor that's hard to move materially without breaking the deal.

Buyers who walk during diligence walked too late. Buyers who close on bad deals signed the LOI without testing the assumptions that would have killed it earlier.

The pre-LOI screen is the work that determines which deals deserve diligence dollars. This post walks through the four-pillar framework that surfaces deal-killers before the LOI commits you to finding them.

Why pre-LOI matters

Three real costs attach to an LOI.

Diligence cost: typically $25K-$75K for a small business acquisition, depending on industry complexity and what specialists you engage. Quality of earnings, legal, environmental (if relevant), tax. The bill comes due whether or not the deal closes.

Time cost: 45-90 days during exclusivity, often more. The opportunity cost of not running other deals while this one is in diligence is real, particularly for buyers running a focused search.

Anchoring cost: the LOI price is hard to move down materially without breaking the deal. Small adjustments (5-10%) for specific diligence findings are normal. Large adjustments (20%+) usually mean the deal restarts or dies.

Pre-LOI work is the cheapest way to convert maybe-deals into either yes-deals or no-deals before any of those costs trigger.

The four-pillar screen

Four structural questions cover the deal-killer surface area. A pre-LOI screen is asking each one in order, with the next pillar only mattering if the previous ones cleared.

Pillar 1: Does the headline SDE survive lender-grade normalization?

The CIM presents the seller's case for SDE. Lenders apply their own normalization. Buyers should apply both.

Three adjustments matter most: market-rate owner replacement (typically $80K-$150K out of SDE), removal of unsupportable add-backs (Tier 3 items that depend on future assumptions), and conservative treatment of working-capital-funded growth (revenue that came from financing receivables rather than from operations).

A deal with $1.2M of broker-presented SDE that normalizes to $950K under lender-grade rules has a different multiple. Same business. Different math. The buyer's downside is anchored to the normalized number, not the broker number.

For the underlying mechanics of SDE normalization, see our SDE formula and add-back guide.

Pillar 2: Does the multiple clear comp discipline?

Industry-specific multiple ranges exist for a reason. SMB deals typically transact in well-defined bands by industry: services 2.5-4x, light manufacturing 3-5x, recurring revenue businesses 4-7x, vertical-specific operators (HVAC, plumbing, etc.) 3-5x with quality premiums.

A deal priced at the top of its band needs to justify why. A clear answer: documented recurring revenue, defensible margins, strong customer retention, recent operating improvements with sustained track record. A weak answer: "the seller built it over 30 years" or "there's growth potential" (which is true of most businesses).

A deal priced at 50% above the band — without a real justification — is signaling either that the seller's expectations are out of sync with the market, or that there's a story in the file that hasn't been disclosed yet.

Pillar 3: Does the deal clear SBA-fundable thresholds?

Most SMB acquisitions in the $500K-$10M range close with SBA 7(a) financing. The lender's underwriting determines whether the deal is financeable at the proposed structure.

Key thresholds: DSCR of approximately 1.15x minimum on most lender files, 1.25x for stronger files. Goodwill financing rules under SOP 50 10 8. Equity injection of 10% minimum, with specific rules on what counts. Seller-note treatment (full standby vs partial vs principal-paying).

A pre-LOI screen runs the lender's math at the proposed price and structure. If DSCR is below 1.15x, the deal needs a different structure (lower price, larger seller note, more buyer equity) or it doesn't fund. Better to surface that before LOI than to discover it 60 days in.

Pillar 4: Does the business transfer cleanly to a new operator?

Transferability is the pillar that gets the least pre-LOI attention and produces the most post-close surprises. Three sub-questions matter.

Customer concentration: any single customer above 15% of revenue, or any handful of customers above 50% combined, signals concentration risk. The buyer's downside includes losing that customer in transition.

Owner-embedded relationships: vendors, key customers, or referral sources that come to the business because of the owner specifically, not because of the business itself. Transition planning for these is a real diligence item, not a checkbox.

Key employee dependency: businesses where one or two non-owner employees hold critical operational knowledge or customer relationships. Loss of those employees during transition can break the deal economics.

How to actually run the screen

The screen takes one to two weeks of work if the broker file is well-prepared and the buyer has a structured process. Less if the file kills itself early; more if the deal is borderline and worth pulling on.

Week one: pillars 1 and 2. Normalize the SDE. Apply industry-specific multiple bands. If the deal doesn't clear these, it doesn't proceed.

Week two: pillars 3 and 4. Run the SBA underwriting math. Identify the top three transferability risks and run them past the broker. Specific deliverables from the broker: customer concentration breakdown, key-employee tenure and role, owner involvement summary.

By end of week two, the deal is either ready for LOI (with eyes open on the remaining diligence items), modified to a different structure (lower price, different terms), or killed.

Walking pre-LOI vs walking from diligence

Walking from a deal pre-LOI is cheap and reversible. The buyer can revisit the deal in six months if circumstances change. The seller hasn't committed to anything. The broker keeps working the deal.

Walking during diligence is expensive. The buyer has spent diligence costs that don't come back. The seller's expectations have hardened around the LOI price. The broker has signaled to other buyers that this deal is in process, which is hard to reverse.

Closing on a bad deal is the most expensive option. Personal guarantees on SBA debt, working capital obligations, customer transition risks — all live with the buyer for years.

The pre-LOI screen exists to make the cheap walk the most common outcome, the expensive walk rare, and the bad close almost never.

What to bring to the broker conversation

A buyer running this screen well has three things ready before the broker conversation.

A specific list of documents needed to complete the screen: financial statements with backup, customer concentration data, key-employee summary, owner-involvement summary, lender willingness to discuss the file. The list is short and specific, not a generic 30-item checklist.

A clear point of view on the deal: what the buyer thinks the deal is, what the buyer thinks the risk profile is, and where the buyer's preliminary view of the structure lies. This isn't a final position; it's the starting point for a structured conversation.

A timeline for the screen: typically "we'll have a decision on LOI within two weeks of receiving complete information." Brokers running quality processes appreciate this — they can plan around it. Brokers running rushed processes will push back on it, which is itself diagnostic information.

Worked example: a $4.2M HVAC deal through the four-pillar screen

The CIM presents a residential and light-commercial HVAC business in the Southeast. Asking price $4.2M. Stated SDE $1.05M on $4.8M trailing revenue. 4.0x multiple. Single owner who's run it for 22 years; 14 employees including the owner. Revenue mix: 60% service contracts, 30% install and replacement, 10% emergency calls. The owner is 64 and motivated to sell within 12 months.

The prospective buyer is a first-time SBA-financed acquirer with $400K of available equity, a pre-qualified preferred lender, and a six-month search timeline. The deal is the third one the buyer has screened.

Pillar 1: SDE normalization

The reported $1.05M SDE includes four meaningful add-backs.

• Owner W-2 salary: $220K reported. Market-rate replacement for an operating owner in this role estimated at $110K (lender consultation suggested $100K-$120K range). Add-back: $110K.
• Truck and vehicle expenses: $35K of personal-use add-back across two company trucks the owner uses for service calls and personal trips. The personal-use split is the seller's judgment.
• One-time legal: $25K (2024 settlement of a contractor wage dispute). Documentation exists.
• Spouse on payroll in admin role: $42K (15 hours per week, handling invoicing and scheduling).

Buyer's tiering of the bridge:

• Tier 1 (documented): $110K owner-comp adjustment, provided W-2s confirm and the role definition is clear. $25K legal settlement, provided the case file and payment documents exist.
• Tier 2 (reasonable but unverified): $35K truck personal-use split — the underlying expense is real, the personal-vs-business allocation is estimated.
• Tier 3 (assumption): $42K spouse payroll — depends on whether the admin function will be eliminated or replaced. The buyer plans to replace the role with a $25K/year bookkeeping subscription plus 10 hours/week of part-time admin help at $20/hour ($10K/year). Effective replacement cost: $35K. Of the $42K add-back, $35K converts to a recurring cost (Tier 1, but as an offset), leaving $7K of genuine adjustment.

Lender-normalized SDE: starts at $1.05M, subtract $35K for the spouse-role replacement reality, subtract roughly $10K for a conservative haircut on the truck personal-use estimate, leaves approximately $1.01M.

Headline SDE was $1.05M. Tier-adjusted underwriting SDE is $1.01M — a 3.8% adjustment, well inside tolerance.

Pillar 1 clears. No price flexibility needed from normalization, but the diligence list now has three specific items: W-2 backup for the owner-comp adjustment, legal documentation for the settlement, and a vehicle-use log to support the truck split.

Pillar 2: Comp discipline

Local-services HVAC operators with documented service-contract bases typically transact at 3.0-4.0x SDE in the Southeast region. The 4.0x ask is at the top of the band.

Justification analysis:

• 60% service-contract revenue: strong indicator of recurring earnings. Service contracts in HVAC typically renew at 85-92% per year when service quality holds. Premium-band justified, conditional on retention data.
• 22-year operator: stable customer base implication. The risk is the inverse — owner-embedded relationships that may not transfer.
• 14 employees: scaled beyond owner-only service capacity. Operational durability implication.
• Asking $4.2M on $4.8M revenue = 0.88x revenue multiple. In line with industry comps (typically 0.7x-1.0x for service-heavy HVAC).

A 4.0x ask is defensible if service-contract retention data is in the file. Without retention data, the multiple should compress toward 3.5x ($3.5M instead of $4.2M — a meaningful spread).

Pillar 2 clears with a documentation condition. Diligence note: request three years of service-contract renewal data and customer-level revenue history.

Pillar 3: SBA fundability

At the proposed $4.2M purchase price with 10% buyer equity injection ($420K), the SBA 7(a) loan amount is roughly $3.78M.

Current SBA 7(a) terms (illustrative, mid-2026): ~10.5% rate, 10-year amortization for goodwill-heavy deals. Annual debt service: approximately $610K.

Lender's underwriting math on the file:

• Underwriting SDE (lender version): $1.01M (matches buyer's tiered view after normalization)
• Less buyer's market-rate salary as operating owner: $120K (lender's standard for this role)
• Less working capital reserve requirement: ~$30K annually (1 month of operating expenses, amortized)
• Cash available for debt service: $860K
• Debt service required: $610K
• DSCR: 1.41x on stronger lender files; 1.15x on stricter ones depending on stress scenarios applied

Math checks out for fundability. But: with $400K buyer equity and $420K equity injection requirement at the headline price, the buyer is over their equity threshold by $20K. Plus closing costs ($60K), plus working capital injection requirement ($50K), plus post-close reserves the lender wants to see ($75K-$100K), the buyer is short $200K-$240K relative to the proposed structure.

Two structural options surface:

1. Lower the purchase price. A $3.95M price at 10% injection requires $395K equity, leaving more headroom for closing and reserves.
2. Use a standby seller note as equity injection. Under current SOP 50 10 8 rules, a portion of the seller note can count toward buyer equity if it meets standby terms. A $300K standby seller note (24-month full standby, subordinated to SBA) frees up $300K of buyer cash for reserves and closing costs.

Option 2 preserves the seller's headline price while addressing the buyer's cash position. Most experienced sellers prefer this — they get the asking price on paper, even if a portion is deferred.

Pillar 3 clears conditionally. The deal funds, but the structure needs modification. Standby seller note recommended.

Pillar 4: Transferability

Three sub-questions on transferability.

Customer concentration. The buyer requests revenue-by-customer for the top 10 customers across three years. The broker provides it in 48 hours — itself a positive signal about file quality.

Findings: largest service-contract customer (a small commercial property management firm) represents 8% of revenue. Top 5 customers represent 22%. Top 10 represent 38%. No single-customer concentration risk. Concentration is broadly distributed — strong for transferability.

Owner-embedded relationships. The owner has personally sold most service contracts in the early years and historically handles renewal conversations on the top 10 accounts. The 22-year tenure is a transferability signal in both directions: long-term customer relationships exist, but they may be owner-specific rather than company-specific.

The diligence test that will matter: a customer-interview sample (3-5 anchor customers) during diligence, asking explicitly whether they would continue service under new ownership and what would influence that decision. Flagged as a top-three diligence priority.

Key employee dependency. Lead service tech has 12-year tenure, handles roughly 40% of service hours, and is the de facto technical lead on complex installs. Loss during transition would be a real problem.

The buyer requests employment terms and compensation history. The lead tech is at $78K base + bonus, with a 4-week vacation and standard benefits. Industry-comparable. Retention risk during transition is manageable through a transition bonus structure ($10K-$25K conditional on 12-month retention) negotiated into the deal structure.

Pillar 4 surfaces two operative risks: owner transition on top-10 customer renewals, and lead-tech retention. Neither is a deal-killer; both expand the diligence scope and inform the close structure.

Screen outcome

After two weeks of pre-LOI work, the buyer arrives at a clear position:

• The deal underwrites at $1.01M of normalized SDE
• The 4.0x multiple is defensible if service-contract retention data backs it (still to be confirmed in diligence)
• SBA financing works with a structural modification — standby seller note recommended
• Transferability risks are real but addressable through diligence scope and transition structure

Proposed LOI structure: purchase price $4.0M (mild reduction from $4.2M, reflecting the 3.8% SDE adjustment), $400K cash equity injection from buyer, $400K standby seller note (24-month full standby, counts toward equity), $3.2M SBA 7(a) loan. Diligence priorities: service-contract retention data, customer interview sample, lead-tech retention conversation, owner transition plan.

The seller accepts the modified structure. LOI signs at week three. Diligence runs 70 days. Deal closes 90 days after LOI at the modified structure.

First-year operating reality: actual normalized SDE comes in at $980K (within 3% of the pre-LOI projection), service-contract retention at 89% (consistent with industry benchmark), and the lead service tech accepts the transition bonus and stays. The pre-LOI screen accurately predicted the deal's financial reality and surfaced the structural modification that made the financing work.

What the screen prevented

The headline asking price would have committed the buyer to $4.2M against $1.01M of underwriting SDE — a 4.16x multiple on the lender's view. The structure as initially proposed would have left the buyer with no working capital reserves post-close. Without the pillar 3 analysis, the deal likely would have failed underwriting at week 6 of diligence after the buyer had spent $40K-$60K on QoE, legal, and operational diligence.

The two weeks of pre-LOI work converted that failure scenario into a clean LOI at a workable structure — and gave the buyer a clear-eyed view of the diligence priorities before any diligence dollars were spent.

Related reading

• Letter of Intent for Buying a Business: Complete Guide + Free Template — what to put inside the LOI once the screen clears
• Confidential Information Memorandum (CIM) Guide — reading the broker file as an underwriter
• How to Calculate SDE: Formula + Add-Back Examples — the normalization math behind Pillar 1
• How to Do Due Diligence on a Small Business Acquisition — what happens after the LOI is signed