How I Evaluate a Business Deal: The PE Criteria I Use Before I Write an Offer

Private equity criteria for evaluating a business deal weigh five things before anything else: normalized EBITDA of $500k+, a debt service coverage ratio (DSCR) of 1.5x or higher, customer concentration under 15%, a clear path to a 3-5x MOIC over a 5-7 year hold period, and a target IRR of 20%+ net of fees. Everything else — the pitch deck, the seller’s story, the growth “opportunity” — is noise until those five numbers clear. Score the deal against them first, then decide whether to run full diligence.

Look, I’ve done 300+ deals over 30 years. The ones that hit the model all cleared the same criteria going in. The ones that almost buried me? I let a good story override the numbers.

Here’s the framework I actually use — the same one we teach inside Dealmaker Academy — laid out the way a PE analyst would score it.

The 5 PE Criteria That Decide Whether a Deal Is Worth Diligence

Before I read the CIM cover-to-cover, I run the deal through five gates. If it fails any two of them, I pass. Life is too short to negotiate on a target that can’t clear the model.

1. Normalized EBITDA of $500k+. Add back one-time expenses, owner comp above market, and non-recurring items. Below $500k EBITDA, the deal usually can’t carry acquisition debt and pay me. That’s a job, not an investment.
2. DSCR ≥1.5x on the proposed capital stack. Debt service coverage under 1.5x means one bad quarter takes you underwater. Non-negotiable.
3. Customer concentration under 15%. No single customer over 15% of revenue. Once you go higher, you’re not buying a business — you’re buying that customer’s continued mood.
4. Modeled 3-5x MOIC on a 5-7 year hold. Multiple on invested capital, not just cash flow. If the exit math doesn’t land there in the base case, walk.
5. Target IRR of 20%+ net of fees. Below that, the risk-adjusted return doesn’t beat easier alternatives. PE benchmarks live here for a reason.

These five criteria kill 80% of the deals I look at in under an hour. That’s the point. The job isn’t to fall in love — it’s to find the 1 in 20 that clears the bar.

Quality of Earnings: What You’re Actually Buying

Quality of earnings (QoE) is the process of turning reported EBITDA into normalized, run-rate EBITDA that a buyer can actually underwrite. The seller’s number is a starting point. Your number — after add-backs, deductions, and true-ups — is what you value the deal on.

What I strip out and what I add back:

• Owner compensation above market rate — add back the excess.
• One-time legal, consulting, or restructuring costs — add back if truly non-recurring.
• Personal expenses run through the P&L — the vehicle, the country club, the family cell plan — add back, but verify with tax returns.
• Deferred maintenance and understaffing — deduct. If the seller has been running lean to inflate EBITDA, that catches up to you in month one.
• Revenue quality — recurring revenue trades at 3-4x the multiple of one-time revenue. Weight it that way in your model.

Any deal over roughly $2M in purchase price gets a third-party QoE from an accounting firm before I sign. The cost is small versus the price of buying reported EBITDA that turns out to be air.

The Financial Screen: DSCR, Debt Capacity, and Free Cash Flow

Once EBITDA is real, I stress-test the capital stack. This is where most first-time buyers get wrecked — they treat the seller’s asking price as the constraint instead of the debt the business can carry.

• Debt service coverage ratio (DSCR): normalized cash flow divided by annual debt service. 1.5x minimum. 2.0x preferred. Below 1.5x, the SBA won’t lend and neither should you.
• Free cash flow after debt service: this is your actual return. If it doesn’t clear your required distribution plus a reserve, the deal is too thin.
• Working capital sufficiency: confirm the business has enough working capital to run day one without a cash injection. Negotiate a working capital peg in the LOI.
• Debt-to-EBITDA at close: total leverage under 3.0-3.5x on a lower-middle-market deal keeps the covenants comfortable.
• 3+ years of consistent profit, ideally through a downturn. That’s proof of a business, not a run of good luck.

Valuation: Comps, DCF, and Precedent Transactions

The three PE-standard valuation methods are Comparable Company Analysis, Discounted Cash Flow, and Precedent Transactions. Use all three. They triangulate. If two of them come in inside a tight range and one is an outlier, you’ve usually found the truth.

1. Comparable Company Analysis (CCA). Pull EV/EBITDA and EV/Revenue multiples from similar businesses that recently transacted in the same sector and size band.
2. Discounted Cash Flow (DCF). Project free cash flow forward 5-7 years, apply a terminal value, discount back at your cost of capital. Sensitivity-test the discount rate and terminal growth assumption.
3. Precedent Transactions. What did buyers actually pay for lower-middle-market businesses in this vertical over the last 24 months? Sites like BizBuySell and IBBA reports give you the reality check.

Recurring-revenue businesses trade at 5-8x EBITDA in lower-middle-market. Service businesses with owner dependency trade at 2-4x. Match the method to the model.

And remember — focus on terms over price. A seller-financed deal at 95% of asking with a 5-year note at reasonable interest beats an all-cash offer at 70% of asking almost every time. See how we structure creative financing if you’re new to that side.

Risk Assessment: Concentration, Cyclicality, and Post-Close Execution

Risk is what determines your discount rate. The higher the risk, the higher the return I need — or the lower the price. The four risk categories that actually move the model:

• Customer concentration. One customer over 15% of revenue is a yellow flag; over 30% is a red one. Discount the multiple or restructure the deal with a large seller note.
• Supplier or platform concentration. Single-source suppliers, one Amazon channel, one distributor controlling half the revenue. Terms can change overnight.
• Owner dependency. If the seller works 40+ hours a week, subtract the market cost of replacing that role from EBITDA before you value the deal. Owner-operator is not the same as owner-investor.
• Cyclicality and regulation. Discretionary sectors at the top of the cycle — home services, construction, luxury retail — get underwriter haircuts. Same with industries facing pending regulatory shifts.

Risks don’t kill a deal by themselves. They just reprice it. Weight them, price them into the offer, or ask the seller to hold paper against them.

The Exit Thesis: MOIC, IRR, and Hold Period

Before I buy, I decide how I’m going to sell. PE thinks in exits from day one. If you don’t have a clear exit thesis at close, you don’t have an investment — you have a hobby with a bank loan attached.

The exit variables I model at LOI:

• Hold period: 5-7 years is the standard PE window. Shorter than 3 and you haven’t had time to execute the value-creation plan. Longer than 8 and IRR gets crushed by the time value.
• Exit multiple assumption: should be conservative. If you buy at 4x EBITDA, don’t underwrite an 8x exit unless you have a documented reason (roll-up, category shift, scale threshold).
• MOIC target: 3-5x multiple on invested capital in the base case. Below 3x, the risk-adjusted return isn’t there.
• IRR target: 20%+ net. That’s the PE benchmark and it’s roughly what public markets can’t reliably deliver.
• Value-creation levers: pricing, bolt-on acquisitions, geographic expansion, digital and marketing upgrades, professionalization of the ops. Two to three clear levers per deal.

How to Run the PE Evaluation on a Real Deal in 5 Steps

The criteria only work with real data — not the CIM, not the seller’s stories, real data.

1. Pull 3 years of tax returns, P&Ls, and bank statements. Reconcile them against each other. Discrepancies get logged and priced in.
2. Normalize EBITDA. Owner comp, one-time items, personal expenses, deferred maintenance. Land on a run-rate number you can defend.
3. Screen against the 5 gates above. EBITDA, DSCR, concentration, MOIC, IRR. Pass or fail in under an hour.
4. Triangulate valuation. Comps, DCF, precedents. Where two of the three converge is your zone.
5. Model best/base/worst-case exits. Base case has to clear your IRR and MOIC targets. Worst case shouldn’t wipe you out.

Deals that clear all five steps get an LOI. Deals that fail two or more get a polite no. The ones in the middle get restructured — usually with more seller financing, an earnout, or a bigger holdback — to move them across the line.

Where Evaluation Meets Negotiation

Your evaluation isn’t just diligence — it’s negotiation ammo. Every weakness you find justifies a lower price, a larger seller note, or an indemnification. Every risk justifies a holdback or escrow. Every opportunity? Keep those to yourself. Never hand the seller a reason to raise the asking price.

Post-close, your risk list becomes your fix-it list. Attack them in order of cash-flow impact. Studies consistently show that most acquisitions that underperform failed at post-close integration — and almost every one of those failures traces back to a risk that showed up in evaluation and never got addressed. Don’t be that statistic.

Frequently Asked Questions

What are the main criteria private equity uses to evaluate a business deal?

Private equity evaluates deals against five core criteria: normalized EBITDA (typically $500k+ in lower-middle-market), a debt service coverage ratio (DSCR) of 1.5x or higher, customer concentration under 15%, a modeled 3-5x MOIC over a 5-7 year hold period, and a target IRR of 20% or higher net of fees. Deals that fail two or more of these usually don’t move past initial screening.

What is a good EBITDA multiple for buying a business?

In the lower-middle-market, recurring-revenue businesses commonly trade at 5-8x EBITDA. Owner-dependent service businesses trade closer to 2-4x. The right multiple depends on revenue quality, customer concentration, growth rate, and the sector. Triangulate using Comparable Company Analysis, Discounted Cash Flow, and Precedent Transactions rather than relying on any single method.

What is DSCR and why does it matter in an acquisition?

DSCR is the debt service coverage ratio — normalized cash flow divided by annual debt service on the acquisition loan. A DSCR of 1.5x or higher means the business generates 50% more cash than it needs to cover the debt, leaving room for owner distributions and reserves. Below 1.5x, one bad quarter puts you underwater. It’s a non-negotiable threshold in our framework.

How do you calculate the target IRR and MOIC for a deal?

MOIC (multiple on invested capital) is the total cash returned divided by cash invested — PE targets 3-5x in the base case. IRR (internal rate of return) is the annualized rate that discounts your projected exit cash flows back to your equity check — PE targets 20%+ net of fees. Both are modeled off a base-case exit at a conservative multiple over a 5-7 year hold period.

What is quality of earnings and when do you need one?

Quality of earnings (QoE) is the process of adjusting reported EBITDA to a normalized, defensible run-rate number — adding back owner excess comp, one-time items, and personal expenses, while deducting for deferred maintenance and understaffing. For deals over roughly $2M in purchase price, a third-party QoE from an accounting firm is standard before signing a definitive agreement.

What customer concentration is acceptable in a PE-style acquisition?

No single customer should exceed 15% of revenue. Between 15% and 30% is a yellow flag that either discounts the multiple or restructures the deal with a larger seller note. Above 30% concentration, you’re not really buying a business — you’re buying that customer’s continued willingness to stay. Reprice accordingly or pass.

How long should you hold a business before selling?

The private equity standard hold period is 5-7 years. Shorter than 3 years and you haven’t had time to execute the value-creation plan that drives multiple expansion. Longer than 8 years and IRR gets crushed by the time value of money. Model your exit at LOI, not at year 4.

Where can I learn to evaluate business deals with a PE framework?

Dealmaker Academy walks the full evaluation framework on live acquisition targets with Carl Allen and the coaching team. The Protégé Community is where active dealmakers share evaluations and outcomes with each other. Both are built for people running deals, not people reading about deals.

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Next move: run the 5-gate screen on the next three deals in your pipeline. Track which ones clear the criteria and how those correlate with the deals that actually close and perform. See the other evaluation frameworks we use, or book a coaching call to walk a live target through the model with the team.