Pre-LOI Financial Analysis
Pre-LOI financial analysis tests a seller's earnings adjustments against source evidence before a buyer enters exclusivity, so the buyer can tell what is documented from what still has to be proven — and decide whether the deal deserves deeper diligence. It sorts each adjustment by what supports it, before anyone has committed time, money, or negotiating position to the transaction.
It is not a Quality of Earnings report, an audit, a review, or a valuation. It happens earlier than all of them, and it answers a narrower question: what can this business actually prove it earns?
Maintained by Mark Hirsch, Founder, TrueQoE · Managing Member, Strategic Lever LLC — buyer, seller, operator, and advisor across lower-middle-market transactions.
What is pre-LOI financial analysis?
Short answer: A structured analysis of a seller's reported and adjusted earnings, performed before the letter of intent, that classifies every adjustment according to the evidence available to support it. Its output is a picture of the earnings story's evidentiary state — not an opinion of value, not an attestation, and not a certification.
A seller's earnings figure is a claim. It is usually made in good faith and it is often correct, but it arrives as a number in a package rather than as a set of facts tied to records. Between the listing and the closing, that claim gets tested — by the buyer's advisors, by a Quality of Earnings provider, and, on qualifying SBA transactions from October 1, 2026, by a report the lender commissions.
Pre-LOI financial analysis performs a version of that test at the only point where the answer is still cheap: before anyone is committed.
What does a pre-LOI first pass actually examine?
Short answer: The adjustments. Reported earnings are what they are; the disagreements in a transaction almost always live in the bridge between reported earnings and the normalized figure the deal is priced on.
The recurring subjects:
- Owner compensation — above or below market, and what replacement compensation would actually cost.
- Related-party transactions — rent, payroll, services, and whether the terms are arm's-length.
- Non-recurring items — the legal matter, the equipment failure, the one bad year. Whether they recur is a documentary question, not an opinion.
- Personal expenses run through the business — real, common, and frequently untraceable in the general ledger.
- Accounting-method differences — cash-basis presentation against accrual reality, and what reconciles between them.
- Revenue quality — customer concentration, contract continuity, and whether the revenue that produced the earnings is the revenue a buyer inherits.
What are the three evidence states?
Short answer: Every adjustment lands in exactly one of three states — Documented, Needs support, or Undocumented. There is no score, no percentage, and no overall grade, because the useful information is per-adjustment.
- Documented
- the adjustment traces to source records.
- Needs support
- the adjustment is plausible, but the evidence isn't in the file yet.
- Undocumented
- there is nothing behind it.
The middle state is where the value is. "Needs support" is not an accusation; it is a work item. An owner's vehicle add-back with no invoice attached is a needs-support item on a Tuesday and a documented one on a Thursday, if the invoice exists. The whole argument for doing this before the LOI is that needs-support items are cheap to resolve while the seller still has time and reason to resolve them.
When does pre-LOI financial analysis happen?
Short answer: Before the letter of intent, and — for a seller or a broker — ideally before the listing goes to market. Everything downstream of the LOI happens with a clock running and a party who has already committed.
| Stage | Who is exposed | What an evidence gap costs there |
|---|---|---|
| Before listing | Seller, broker | A phone call and a filing cabinet |
| Before LOI | Buyer | A decision not to proceed, made cheaply |
| Under exclusivity | Buyer | Diligence fees already spent |
| Underwriting | Both | A financing gap, a re-trade, or a dead deal |
| After closing | Buyer | Everything |
How is it different from a Quality of Earnings report?
Short answer: Timing, purpose, and weight. A first pass is preparation; a QoE is verification. One identifies what needs proving. The other proves it, or doesn't. A first pass never substitutes for a QoE, and on qualifying SBA transactions it cannot — that report must be performed by an independent, experienced financial professional and conducted for the benefit of the lender.
| Pre-LOI first pass | Quality of Earnings | Valuation | Audit or review | |
|---|---|---|---|---|
| Question answered | What is supported? | What are normalized earnings? | What is it worth? | Do the statements conform? |
| Who orders it | Broker, seller, or buyer | Buyer or, on qualifying SBA deals, the lender | Lender or party | The company |
| When | Before listing or LOI | After LOI, in diligence | Underwriting | Annually |
| Nature | Analytical | Diligence engagement | Opinion of value | Attestation engagement |
| Output | Each adjustment sorted into three states | Normalized adjusted earnings | A value or range | An opinion |
Who runs a pre-LOI first pass?
Short answer: Any of the three parties, for different reasons. A broker runs one before going to market so the listing is priced on adjustments that will hold up. A seller runs one to find out what needs documenting while there is still time. A buyer runs one before the LOI to decide whether the deal deserves formal diligence at all.
The buyer's version is the one people find hardest to justify until they've been through it once, because it costs money before there's a deal. The answer is arithmetic: formal diligence on a lower-middle-market transaction runs into five figures, and a meaningful share of deals that reach it should never have gotten there. A first pass is the cheaper question asked first.
Does a first pass tell you whether to buy the business?
Short answer: No. It tells you what the financial claims rest on. Whether the business is worth owning is a judgment that includes the market, the customers, the operations, the people, and your own plans — none of which are financial-evidence questions.
This limit is deliberate and it is worth stating clearly, because the adjacent products in this market are frequently sold as certainty. A first pass does not certify anything, does not manufacture confidence, and does not convert an absence of evidence into a favourable conclusion. Absence of evidence is reported as absence of evidence.
What is an evidence gap?
Short answer: An evidence gap exists when an earnings adjustment being relied on in pricing does not yet have the source documentation needed to support it. It is not an allegation that the adjustment is wrong. It is a statement that, right now, nothing in the file proves it.
The distinction matters because most gaps close. A seller who added back $18,000 of owner vehicle expense is usually right, and the lease or the ledger detail usually exists somewhere. Until it is in the file, the adjustment is a claim the deal is priced on and nothing more — and every party downstream will treat it that way.
Three things follow from that:
- An evidence gap is a work item, not a verdict. Its natural resolution is that someone goes and finds the document.
- Gaps get more expensive as the deal advances. The same gap costs a phone call before listing, a re-trade in underwriting, and a write-down after closing.
- The number of gaps matters less than which adjustments have them. Twelve small documented add-backs and one large undocumented one is a very different file from the reverse, and no single score can express that — which is why the analysis reports per adjustment rather than in aggregate.
Terms used on this page
- Pre-LOI financial analysis
- the category: analysis of a seller's financial claims conducted before a letter of intent or exclusivity, to determine whether the earnings story warrants deeper diligence.
- First pass
- a single engagement of pre-LOI financial analysis. Used as a verb: run a first pass.
- Adjustment (add-back)
- an item added to or removed from reported earnings to produce a normalized figure the deal is priced on.
- Documented / Needs support / Undocumented
- the three states an adjustment can occupy after a first pass. Not a score, not a ranking, and never aggregated into one number.
- Evidence gap
- an earnings adjustment being relied on in pricing that does not yet have the source documentation needed to support it. A work item, not a verdict.
- Source record
- the underlying document an adjustment traces to: an invoice, a contract, a payroll record, a bank statement, a settlement agreement, a lease.
Frequently asked questions
Is pre-LOI financial analysis the same as due diligence?
No. It is narrower and earlier. Financial due diligence is the broader work that happens after a buyer commits; a first pass is the analysis done before committing, on the question of what the earnings claims are supported by.
Does a pre-LOI first pass replace a Quality of Earnings report?
No. It happens earlier, serves a different purpose, and carries different weight. On qualifying SBA acquisitions at a Business Purchase Price of $3 million or more, the lender must obtain a QoE performed by an independent, experienced financial professional for the lender's benefit; a first pass does not satisfy that requirement.
Who pays for it?
Whoever orders it — most often the broker or seller before listing, or the buyer before the LOI.
Can it be done from the seller's package alone?
It starts there. The package is the claim; the analysis is about what sits behind it. Where the supporting records aren't available yet, that is itself the finding.
How is it different from a valuation?
A valuation answers what a business is worth. A first pass answers what its earnings claims are supported by. The second is an input to the first.
What happens to adjustments that can't be supported?
That is a decision for the parties, not for the analysis. What a first pass provides is that the decision is made knowingly, before exclusivity, rather than discovered in underwriting.