Exit readiness
Value is decided long before the term sheet
The gaps that quietly discount a business in diligence, and how to close them early.
Price moves after the letter of intent because diligence finds something the seller did not surface first. Across calendar year 2025, diligence findings ended a larger share of lower middle market transactions than financing did. The findings that move price are operational, and they are created years before a process opens: customer concentration, undocumented contracts, a system of record that cannot produce buyer grade reporting, and earnings adjustments the seller cannot evidence.
What actually ends lower middle market transactions?
Diligence findings end more lower middle market transactions than financing does. Axial analyzed 75 unsuccessful transactions across eight firm types and eight industries from calendar year 2025. Diligence findings unrelated to quality of earnings ended 25.3% of them and quality of earnings discrepancies ended a further 21.3%, so the two categories together accounted for 46.6% of broken letters of intent. Financing constraints accounted for 10.7%, down from 21.3% in 2023. The sample is 75 transactions drawn from one platform's flow and reported by the buy side, so the figures are directional rather than a market census.
“These findings frequently surfaced issues outside formal QoE work, including undisclosed legal or compliance risks, customer concentration concerns, and contract issues.”
Axial, Dead Deal Report, 27 January 2026. Source
What does a quality of earnings review not cover?
A quality of earnings review tests whether reported earnings are real. It does not test whether the operation that produced those earnings can carry the growth case written into the letter of intent. The two reviews answer different questions, and the second one is where the 2025 findings above originated.
| Dimension | Quality of earnings review | Operational diligence |
|---|---|---|
| Core question | Whether reported earnings are real, normalized and repeatable. | Whether the operation can carry the growth case after closing. |
| Orientation | Historical and current, examined monthly rather than annually. | Forward looking, and focused on what changes under new ownership. |
| Working capital and the peg | In scope. Net working capital analysis is a standard workstream. | Out of scope. |
| Customer concentration | Partly in scope. Published guidance states the coverage may be incomplete. | In scope, and this is where the largest share of 2025 broken letters of intent originated. |
| Capacity, asset condition and cost to serve | Not in scope of any published quality of earnings definition. | In scope. |
| Assurance provided | None. A quality of earnings study is a consulting engagement rather than an attest service. | None. Operational diligence is advisory work. |
| Who performs it | The transaction advisory practice of an accounting firm. | Operators, run as a separate workstream alongside the financial review. |
The right hand column reflects Albatross's own scope definition. No comparable published standard for operational diligence exists in the lower middle market, which is itself part of why the gap persists.
How does customer concentration change the price and the debt behind it?
Customer concentration is priced twice in a leveraged transaction: once in the offer, and again in the debt that funds it. Campello and Gao, writing in the Journal of Financial Economics in 2017, examined the effect on loan terms.
“Higher customer concentration increases interest rate spreads and the number of restrictive covenants featured in newly initiated as well as renegotiated bank loans.”
Murillo Campello and Janet Gao, Journal of Financial Economics, volume 123, 2017. Source
The same paper reports that concentration shortens both the maturity of those loans and the duration of the banking relationship. The study uses syndicated loan data on public companies, so the mechanism transfers to a private transaction while the magnitudes do not. What transfers is the reason a buyer who borrows to close will discount concentration more sharply than a buyer who does not.
How prepared do sellers arrive at the market?
Most sellers in the relevant size band arrive without formal preparation. The International Business Brokers Association and M&A Source surveyed 300 brokers and advisors reporting 203 completed transactions, with fieldwork run from 1 to 16 April 2026. In the $5 million to $50 million band, 62% of sellers came to market with no formal exit planning. The same quarter recorded a median multiple of 4.5 times EBITDA in that band and a median of four months from letter of intent to close.
One number in that survey inverts the expected pattern. The 62% recorded in the $5 million to $50 million band is higher than the 35% recorded in the $1 million to $2 million band, so the businesses with the most value at stake were among the least prepared in the quarter measured.
What moves after signing even when the transaction closes?
Purchase price adjustments are close to universal, and the mechanism that sets them is negotiated rather than standard. SRS Acquiom examined more than 2,300 private target acquisitions valued at $569 billion and closed between 2020 and 2025. Purchase price adjustments appeared in well over 90% of those deals. Escrows across the sample averaged 12.1% of deal value in 2025, against 10.25% previously.
That population is venture backed and sponsor backed private targets, which sit above the lower middle market in size. The rates should not be read as a description of a $30 million revenue distributor. What the sample does establish is that the closing balance sheet is a contested mechanism, and that the evidence supporting a working capital position has to exist before the mechanism is negotiated.
What closes the gaps, and when?
Five items carry most of the exposure, and each takes months rather than weeks. First, revenue and gross margin by customer for three years, produced from the system of record rather than rebuilt in a spreadsheet. Second, a remediation plan for any customer above a concentration threshold the business has chosen deliberately, with the plan dated and underway before a process opens. Third, a complete contract file with terms, notice periods and assignment clauses identified. Fourth, service level performance measured by system rather than reported by the operator. Fifth, documentary support for every earnings adjustment the seller intends to claim.
Eighteen months is the working window, because each of those five is an operating change rather than a document. Where an item cannot be produced, the absence is itself what diligence finds, and the price adjusts to the absence rather than to the underlying fact.
Sources: Axial, Dead Deal Report, 27 January 2026 (n=75, calendar year 2025) · Campello and Gao, Journal of Financial Economics, 2017 · IBBA and M&A Source, Market Pulse Survey, first quarter 2026 (n=300 advisors, fielded 1 to 16 April 2026) · SRS Acquiom, 2026 M&A Deal Terms Study (more than 2,300 private target acquisitions closed 2020 to 2025) · Baker Tilly, quality of earnings report guidance · Deloitte, operational due diligence explained (30 October 2023). Last reviewed 18 August 2026.
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