Criteria for Evaluating Business Purchases: The Checklist I Run on Every Target

The criteria for evaluating business purchases are the specific tests a buyer applies to a target company after it’s been identified — covering financial performance (recasted EBITDA, DSCR, quality of earnings), operational health (owner dependency, systems, customer concentration), market and strategic fit (industry trend, competitive moat, growth path), deal structure (price, terms, financing feasibility, tax treatment), and red flags (undisclosed liabilities, customer or key-employee risk, working-capital games). Every real deal I’ve closed passed all five categories. The ones I walked away from failed at least one.

This is not target selection — that’s a separate go/no-go screen I run before I ever get here. This is the deeper evaluation you do after a target passes the initial screen, before you commit real diligence dollars, and long before you sign a purchase agreement. I’ve bought and helped students buy 300+ businesses across 30 years. The evaluation criteria below are the same ones I use on my own money.

Work through the five categories in order. If a target fails a category, price and terms rarely fix it — walk or restructure. Here’s the full checklist.

Financial Evaluation Criteria

Financial evaluation is where you separate the real cash flow from the story the seller is telling. You’re not reading tax returns to admire them — you’re recasting them into a picture of what the business actually earns for an owner-operator.

• Recasted (Adjusted) EBITDA. Add back the owner’s salary above market, personal expenses running through the P&L, one-time legal or professional fees, and non-recurring items. This is the number you’ll actually finance against. A gap between reported EBITDA and recasted EBITDA is normal; a gap you can’t tie to a specific document is a red flag.
• Three to five years of financials. Get income statements, balance sheets, and cash flow statements. Look for the trend line, not a single-year snapshot. Flat revenue with rising margins is often better than growing revenue with collapsing margins.
• Quality of earnings. Are the earnings recurring or one-time? Contracted or transactional? Concentrated in one product line or diversified? A business with 80% recurring revenue is worth a materially higher multiple than one with 80% one-off project work.
• DSCR the recasted number carries. Cash flow positive with a DSCR of 1.5x or higher after all debt service is the minimum. If the recasted EBITDA doesn’t service the debt at that coverage, the price is wrong or the stack is wrong. Non-negotiable.
• Working capital. How much working capital does the business need to operate? Sellers love to strip it out at close and hand you a shell. Peg net working capital in the LOI and true it up at closing.
• Tax returns vs. financials. They should reconcile. If they don’t, you’re either looking at aggressive tax planning or aggressive financial reporting. Both are questions you need answered before you sign.

Financial evaluation isn’t a spreadsheet exercise. It’s a story you’re building about how this business makes money, and whether that story survives contact with real diligence.

Operational Evaluation Criteria

Operational criteria tell you whether the business runs on systems or runs on the seller. A business that runs on the seller isn’t a business — it’s a job you’re paying to buy.

• Owner dependency. How much of the revenue, key relationships, and technical knowledge lives in the owner’s head? A seller who is the top salesperson, the head technician, and the only signer on major accounts is a transition risk. Structure a transition period and a portion of the price to bridge it.
• Customer concentration. Any single customer above 20% of revenue is a concentration risk. Above 40% and the deal becomes a bet on that one relationship. Get the concentration table before the LOI.
• Key employees. Who runs operations day-to-day? Are they staying? Do they have stay bonuses or employment agreements? A key manager walking out post-close can gut the business in a quarter.
• Documented systems and SOPs. Are the processes written down or in someone’s head? Documented playbooks are worth real multiple points because they make the business transferable.
• Vendor and supplier terms. Are there exclusive contracts? Change-of-control clauses that let a supplier terminate on sale? Long-term price locks that expire six months post-close? Read every material contract.
• Facility, equipment, and technology. Deferred maintenance is deferred capex you’ll inherit. Aging equipment, an outdated ERP, or a lease that expires in 18 months all move the effective price.

Operational evaluation is where you decide whether the business can run without heroics — including yours.

Market & Strategic Evaluation Criteria

You’re not just buying today’s cash flow. You’re buying a position in a market. Market and strategic criteria tell you whether that position is a tailwind, a headwind, or a slow leak.

• Industry trend. Is the industry growing, flat, or declining? Buying into decline requires a specific thesis — consolidation, roll-up, or repositioning. Don’t buy a shrinking market by accident.
• Competitive moat. Why does this business win against competitors? Proprietary technology, exclusive distribution, brand, switching costs, network effects, location? A business with no moat competes on price, and price competition eventually crushes margin.
• Market share and positioning. Is the business the #1, #2, or #7 player in its segment? A dominant local operator in a fragmented industry has real strategic value; a mid-tier player in a consolidating industry is often a target for a bigger acquirer — sometimes a buying opportunity, sometimes a warning.
• Customer demographics and demand. Who buys, how often, and why? Recurring B2B customers behave differently than one-time B2C. Demand trends among the actual customer base matter more than aggregate industry data.
• Growth path. Is there a clear lever you can pull post-close — new geography, new products, cross-sell, price increase, digitization? A business with obvious growth levers is worth more than one that’s already at its ceiling.
• Regulatory and technology risk. New rules, new platforms, or new tech can wipe out a business model. Know what could break the industry in the next 3-5 years and price for it.

Deal-Structure Evaluation Criteria

A great business at a bad structure is a bad deal. A good business at a great structure is often a great deal. Structure is where the money is actually made.

• Asking price vs. multiple. Anchor on multiple of recasted EBITDA relevant to the industry and size — small businesses commonly trade in ranges but every deal is specific. Sellers who won’t share the multiple math are selling a story, not a business.
• Seller willingness to carry paper. Will the seller finance part of the price? A seller who says no on principle often becomes a seller who says yes at 15-20% carry once the deal is real. Always ask.
• Financing feasibility. Can you actually fund it? SBA 7(a) for deals under $5M in enterprise value, conventional above that, plus seller notes, mezz, or equity to fill the stack. If no lender will touch the deal at your proposed structure, it’s not a deal yet.
• Asset vs. stock sale. Asset deals give the buyer a stepped-up basis and leave historical liabilities with the seller — usually the buyer’s preference. Stock deals move contracts, licenses, and tax attributes intact but bring the history with them. Talk to your CPA before you frame the offer.
• Earnouts, holdbacks, and escrows. These shift risk back to the seller. Earnouts on hitting future performance. Holdbacks in escrow for indemnification claims. Non-compete and non-solicit backed by real teeth.
• Personal guarantees and covenants. Anyone owning 20%+ signs a personal guarantee on SBA debt. Know what you’re signing, what the DSCR and distribution covenants require, and what it takes to release the guarantee post-close.

Focus on terms over price. Always. A slightly higher price with seller carry, a full standby note, and generous earnouts often beats a lower cash price with none of that structure.

Red-Flag Evaluation Criteria

Red flags are the things that don’t kill a deal on their own, but should force you to slow down, price them in, or walk. Any two together is usually a walk.

• Financials that don’t reconcile. Bank statements, tax returns, and management P&L should agree. When they don’t, either the reporting is sloppy or the numbers aren’t real.
• Undisclosed liabilities. Pending lawsuits, tax notices, employee claims, environmental issues, unrecorded seller notes, deferred vendor payables. Push a full lien search and a formal representations-and-warranties list.
• Working-capital games. Seller stripping cash and receivables at close, letting inventory run down, delaying payables to inflate short-term cash. Peg working capital in the LOI.
• Customer or key-employee risk. A top customer that hasn’t renewed, or a key manager already talking to competitors. Both are quiet in early diligence and loud after close.
• Change-of-control clauses. In customer contracts, vendor agreements, leases, and existing debt. Any one of them can blow up a close if you don’t get consent in advance.
• Motivated seller ≠ desperate seller. Retirement, divorce, or health are normal reasons to sell. A seller who won’t explain why they’re selling, or whose story keeps changing, is a red flag by itself.
• No documentation. No SOPs, no org chart, no customer contracts, no accounting policy. If the business only exists in the seller’s head, you’re not buying an asset — you’re buying a promise.

How to Run the Evaluation in Order

1. Recast the financials first. If recasted EBITDA doesn’t service the debt at DSCR ≥1.5x under a realistic capital stack, the price or structure has to change — nothing else matters yet.
2. Stress-test operations. Owner dependency, customer concentration, key employees, documented systems. Any single 8/10 problem is manageable; multiple 8/10 problems compound.
3. Confirm market and strategic fit. Industry trend, moat, and growth path. This is where you decide the business is worth owning at all.
4. Model the deal structure. Purchase price, financing stack, asset vs. stock, seller carry, earnouts, holdbacks. Bring your CPA and attorney in before the LOI.
5. Walk the red-flag list. Every deal has red flags. The question is whether they price in, structure around, or walk you.

Run all five in order on every target. Don’t skip categories because the deal looks good. The reason bad deals close is buyers fall in love before they finish the checklist.

Frequently Asked Questions

What are the main criteria for evaluating business purchases?

The main criteria for evaluating business purchases are financial performance (recasted EBITDA, quality of earnings, DSCR, working capital), operational health (owner dependency, customer concentration, key employees, documented systems), market and strategic fit (industry trend, moat, growth path), deal structure (price, terms, financing feasibility, tax treatment), and red flags (undisclosed liabilities, financials that don’t reconcile, working-capital games). Every real deal has to pass all five categories.

How is business-purchase evaluation different from target selection?

Target selection is a go/no-go screen you run before spending real time on a business — size, industry, geography, initial financial thresholds. Business-purchase evaluation is the deeper analysis you apply after a target passes that screen: recasting financials, testing operational independence, checking strategic fit, structuring the deal, and hunting red flags. Selection tells you whether to look; evaluation tells you whether to buy.

What is recasted EBITDA and why does it matter?

Recasted (or adjusted) EBITDA is the reported EBITDA of the business plus legitimate add-backs — above-market owner compensation, personal expenses run through the company, one-time legal or professional fees, and non-recurring items. It matters because lenders and buyers underwrite the business on recasted EBITDA, not the tax-return number. Every add-back has to be documented; anything you can’t tie to a specific expense line comes out of the pile.

What DSCR should a business hit to be worth buying?

A debt service coverage ratio of 1.5x or higher on the recasted EBITDA after the full capital stack is the minimum I’ll accept. That means for every $1 of debt service, the business generates at least $1.50 of cash flow. Below 1.5x, you’re betting on growth to service the debt. Cash flow positive with DSCR ≥1.5x is non-negotiable.

What level of customer concentration is a deal-killer?

Any single customer above 20% of revenue is a concentration risk you need to price. Above 40% and the deal turns into a bet on that one relationship — usually only worth doing if that customer is under a multi-year contract with change-of-control consent and a real reason to stick around. Get the customer concentration table before you sign an LOI, not during diligence.

Should I structure the purchase as an asset sale or a stock sale?

Most buyers prefer an asset sale because it gives them a stepped-up tax basis and leaves the seller with historical liabilities. Sellers often prefer a stock sale because it’s usually more tax-efficient for them and transfers contracts, licenses, and tax attributes intact. The answer depends on the target’s contract portfolio, licensing regime, and both sides’ tax positions. Talk to your CPA before framing the offer, not after.

What are the biggest red flags when evaluating a business to buy?

The biggest red flags are financials that don’t reconcile across bank statements, tax returns, and management P&L; undisclosed liabilities like pending lawsuits or tax notices; working-capital games at close; unexplained changes in the seller’s reason for selling; customer or key-employee risk that’s quiet in early diligence; change-of-control clauses in material contracts; and a business with no documented systems. Any single red flag is manageable; two together is usually a walk.

Where can I learn to run these evaluation criteria on real deals?

Dealmaker Academy teaches the full evaluation and diligence framework — financial recasting, operational assessment, deal structuring, and red-flag walks — on live acquisition targets with Carl Allen and the coaching team. The Protégé Community is where active dealmakers pressure-test targets against these criteria before they commit real capital.

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Next move: pull the last target you looked at and run it through all five categories in order. See the 5-phase evaluation framework we use on every deal, or book a coaching call to walk a specific target through the checklist with the team.