10 Red Flags in Small Business Acquisitions
9 min read
Every experienced small business buyer has a story about a red flag they ignored and regretted. Red flags rarely announce themselves clearly. They appear as inconveniences, explanations, or unique situations that the seller or broker has a ready answer for. Here are the ten most important red flags, in order of severity.
Red Flag 1 — SDE Margin Far Above Industry Benchmarks
If the seller's stated SDE margin is 15–20 percentage points above the typical range for their industry, something is wrong. Ask for documentation of every add-back. Request three years of tax returns. Compare to industry benchmarks.
Red Flag 2 — DSCR Below 1.25x at Asking Price
If a deal fails SBA minimum DSCR at the asking price, this is a negotiation point, not a deal-killer. But submitting a LOI at asking price on a deal that fails SBA criteria wastes everyone's time. Calculate DSCR before LOI.
Red Flag 3 — Revenue Concentration in One or Two Customers
If 40% or more of revenue comes from a single customer, you are buying a contract, not a business. Any customer representing more than 15% of revenue warrants specific questions about the contractual relationship and what happens to it after the sale.
Red Flag 4 — The Seller Cannot Explain Why They Are Selling
Retirement is legitimate. Pursuing other opportunities without specifics is not. Ask the same question multiple times in different ways. Inconsistency is itself a data point.
Red Flag 5 — Revenue Is Declining Year Over Year
Always request three years of revenue and SDE data. Calculate the compound annual growth rate. If revenue is declining, understand why before you submit a LOI.
Red Flag 6 — No Employees Other Than the Owner
An owner-operated business with no other staff creates immediate key-person risk. When the seller leaves, every customer relationship and operational knowledge leaves with them. This changes the transition period requirements and risk profile significantly.
Red Flag 7 — The Lease Is Expiring or Has No Assignment Clause
A business with less than 24 months remaining on its lease and no renewal option is a significant risk. SBA lenders require lease terms covering at least the loan term. Before LOI, confirm remaining lease time, assignment clause, and landlord willingness to extend.
Red Flag 8 — Unusual Add-Backs That Appeared Only Recently
Compare this year's add-backs to the prior two years. Significant new add-backs in the year or two before listing suggest SDE inflation. Common examples: suddenly expensing a personal vehicle, increasing owner salary in the final year, or adding new one-time expenses that are actually recurring.
Red Flag 9 — Reluctance to Provide Tax Returns
If a seller provides P&L statements but resists providing tax returns, that resistance is itself a red flag. P&L statements are prepared by the seller. Tax returns are filed under penalty of perjury. The discrepancy between the two is where problems hide.
Red Flag 10 — Significant Online Reputation Issues
Search the business name on Google, Yelp, and industry-specific review platforms before spending time on due diligence. For service businesses — spas, restaurants, cleaning companies, childcare — the online reputation IS the business.