From interest to evidence

Cedar Workshop is a fictional learning example.

From interest to evidence

Module One tested acquisition fit. Module Two used early conversations to identify important questions. Now, test the answers.

Consider a new fictional example: Cedar Workshop. You have submitted an indication of interest, or IOI, and the seller has invited you to review more information.

This initial investigation is called preliminary diligence. Its purpose is simple: decide whether the business still makes sense for you. The sequence and information available vary between deals. An IOI does not automatically give you access to everything.

Know what each record tells you

Through the agreed confidential process, request the last three completed years of financial statements and business tax returns. Also request this year's results against the same period last year.

The profit-and-loss statement, or P&L, shows sales, expenses, and profit or loss. Three years reveals trends or an unusually strong year. Monthly figures show busy and quiet seasons.

The balance sheet shows what the business owns and owes. A cash-flow statement, where available, shows cash movements. Profit is not necessarily available cash.

Tax returns show what was reported for tax purposes. Ask your accountant to explain differences from the financial statements. Accounting and tax rules can differ. A filed return is not an audit.

Also request customer revenue and the owner's responsibilities. A data room is a controlled place for these records. Track what arrived and what is missing.

Test the earnings

Read these records together. If Cedar's sales rise but profit falls, which costs grew faster?

You may see EBITDA: earnings before interest, taxes, depreciation, and amortization. It is not take-home cash.

Suppose the seller proposes excluding a consulting expense from adjusted earnings. This is an add-back. The expense happened; would it recur?

Request invoices. Was this a one-time project, or work Cedar still needs?

Removing a necessary cost could overstate expected earnings. Have your accountant assess the support; keep the adjustment unresolved until justified.

Next, test how dependable those earnings are.

Understand customer dependence

Cedar's fictional customer summary shows that one customer generated thirty percent of sales last year. That is thirty dollars out of every hundred.

This is customer concentration: a large share of revenue coming from relatively few customers.

It is not automatically a reason to reject Cedar. It is a reason to ask better questions. How long has the relationship lasted? What do the available agreements say about renewal or cancellation? Is the work committed, or ordered one job at a time?

Historical sales show what happened, not what is guaranteed next. Keep the open questions visible. Do not contact customers outside the agreed process.

Understand the owner's role

Those customer relationships lead to the next question: who maintains them?

Suppose Cedar's owner handles important customers, prepares quotes, and oversees production. Owner dependence means the business relies heavily on that person's work or relationships.

Map the responsibilities, not just the job title. Who could take each task over? What training, hiring, or transition support might be needed?

Then connect the answer back to the numbers. If you need additional management, that has a cost. The business may still be attractive, but your operating plan and expected earnings need to reflect how you would actually run it.

Clarify what you would acquire

A workable plan also depends on what you would acquire.

In Cedar's example, the machinery and tools are proposed to be included, but the building is not. Those are different questions: what assets are part of the purchase, and where can you use them?

Do not assume buying the equipment gives you the right to stay in the building. Ask what arrangement is proposed and have your advisers assess the documents and required permissions.

Record access to the premises as unresolved. A plan that depends on that location needs an answer before you treat it as reliable.

Decide what the findings change

Now bring the findings together. For each important issue, write down the claim, the information reviewed, what remains unclear, and how it affects your decision.

For Cedar, that means the earnings adjustment, customer dependence, owner responsibilities, and premises.

You can advance, revise your assumptions, pause for an answer, or walk away. Progress is not measured by how many documents you collect. It is measured by whether you understand the opportunity better.

A quick check: the equipment looks suitable, but continued access to the building is unresolved. Can your operating plan treat that location as secured?

No. State what is missing and who needs to resolve it.

An informed next proposal

If the initial evidence supports continuing, you may be ready to discuss a letter of intent, or LOI: a more developed outline of the proposed deal. Make the remaining checks explicit.

An IOI or LOI is usually a proposal, not a promise to complete the purchase. But some parts can still be binding. For example, an exclusivity clause can stop the seller from negotiating with other buyers for an agreed period. Without that or another restriction, the seller can generally keep considering other offers. Before signing, have a lawyer check which promises are binding.

The initial investigation informs your proposal. It does not complete the acquisition or replace deeper diligence. Module Four covers that deeper, post-LOI work.