Diligencing the Buyer: How Advisors Verify a Bidder Can Actually Fund the Deal
A specialty chemical distribution business, 47 million dollars of revenue and 6.4 million of adjusted EBITDA, signed a letter of intent at 8.1 times with a buyer who presented beautifully. Two principals with real operating backgrounds in the category, a thesis that was better than ours, and a number at the top of the range. Ninety days of exclusivity. What the seller's team did not establish before granting it was where the equity was coming from. The buyer was an independent sponsor raising the equity deal by deal, and the capital partner named in the pitch had passed six weeks earlier. By day 62 the sponsor was on his third family office. On day 88 he asked for a 40 day extension and a structure with 2.4 million dollars of seller financing that had never been discussed. The seller took it, because by then he had spent 190 thousand dollars on legal and accounting work, told his two largest customers something was happening, and lost the two underbidders who had moved on. The business was fine. The process was fine. The advisor had run diligence on everything except the person writing the check.
Sell-side advisors are trained to prepare a company to be examined. Far less attention goes the other direction, and the asymmetry is strange when you look at it plainly. The buyer will spend 90 days and six figures testing whether the seller's numbers are real. The seller is frequently asked to take the buyer's capacity to close on the strength of a logo on a deck. Exclusivity is the most valuable thing a seller has to give, because it is the moment competitive tension ends and the price stops being defended by anyone but the seller. Handing it to a bidder whose funding has not been verified is the single largest unforced error I see in lower middle market processes.
Funding verification is not one test. It is four different tests depending on who is bidding, and the most common failure is running the private equity test on a buyer who is not a private equity fund.
A committed fund is the easiest case and still deserves three questions. Which fund is this coming from, what vintage is it, and how much dry powder is left in it. A fund in year seven of a ten year life, mostly deployed, with an LP base that has been slow on capital calls is a different counterparty from the same firm's freshly closed vehicle, and the answer changes what happens when the fund's investment committee sees your diligence findings in week nine. Ask for the fund name and size in writing. A fund that will not tell you which vehicle is buying your client is telling you the answer.
A strategic buyer looks safer than it is. Cash on the balance sheet is not the constraint, approval is. The question is what internal authority the person across the table actually holds and what approval still stands between the letter of intent and a signature. Corporate development officers routinely sign non-binding letters that their board has never seen. Ask when the board or the acquisition committee meets, whether this transaction has been presented, and what conditions were attached. For a public acquirer, ask whether the deal is above or below the threshold that requires board action. A strategic who has already cleared internal approval and one who intends to seek it in November are not the same bidder at the same price.
An independent sponsor is the case that has changed most. Sponsors without a committed pool of capital now account for a meaningful and growing share of lower middle market deal flow, and many of them are excellent operators who close reliably with repeat capital partners. The model is not a red flag. What is a red flag is a sponsor who cannot or will not name the capital partner. A credible sponsor will tell you which family office, SBIC, or fundless equity partner has reviewed the thesis, and will produce a letter from them. That letter usually does not legally commit anything, and it does not need to. What it establishes is that a named institution with capital has looked at this specific deal and is prepared to do diligence. A sponsor with a soft letter from a recognized partner is a real bidder. A sponsor with no letter and a reference to strong relationships in the capital markets is a person hoping to syndicate your client's company after the exclusivity clock starts.
A search fund or individual buyer is the fourth case, and there the equity is typically a small committed pool plus investor capital called deal by deal, usually with an SBA or acquisition loan underneath it. The relevant questions are whether the investor base has funded prior acquisitions by this buyer and whether the lender has issued anything beyond a marketing term sheet.
There is a hierarchy here and advisors should know it cold, because buyers use the vocabulary loosely and sellers cannot tell the tiers apart.
At the top is an equity commitment letter from a fund to the acquisition vehicle, specifying a dollar amount and the conditions on which it funds. Below that is a debt commitment letter from a lender, which is a real commitment subject to stated conditions, and which is not the same thing as a term sheet. Below that is a highly confident letter or an indicative financing proposal, which is a lender saying it likes the credit and has not committed anything. At the bottom is a proof of funds screenshot or a bank letter confirming a balance, which proves a balance existed on a date and proves nothing about whether that balance is available for this transaction.
What matters more than the label is the conditionality. Read what the financing is conditioned on, because that is the list of reasons the buyer can walk without consequence. A debt commitment conditioned on final credit approval, on a leverage test measured against a quality of earnings the lender has not yet seen, or on no material adverse change with a definition the lender writes, is a commitment that converts into a renegotiation the moment a diligence finding moves EBITDA. The most useful question an advisor can ask a buyer's lender directly, with the buyer's permission, is what would have to be true for this financing not to fund. Lenders answer that question honestly more often than people expect.
The other thing to establish is the equity check size relative to the total. A buyer funding 55 percent of the purchase price with debt is more exposed to a downward revision in EBITDA than one funding 35 percent, because the debt sizes off a multiple of earnings and the equity has to absorb every dollar the leverage will no longer carry. A 9 percent reduction in EBITDA during diligence does not reduce the price by 9 percent for a highly levered buyer. It reduces the debt available by more than that and forces a conversation about who funds the gap. This is the mechanical reason so many deals reprice after the letter of intent rather than before it, and it is why the composition of a bid belongs in the analysis alongside the number.
The timing point is the whole point. Every question above is easy to ask while three bidders are still competing and nearly impossible to ask with force after one of them has exclusivity. Before exclusivity, a buyer who resists producing financing evidence risks losing the deal. After exclusivity, the same buyer is the only buyer, and the advisor asking is a nuisance rather than a gatekeeper.
So put it in the process letter. Bidders submitting a letter of intent should be required to include their financing structure, the source of equity, the status of debt, and a named contact at each capital source the advisor may call. Make the reference call to the capital partner and the lender before recommending exclusivity, exactly as you would call a customer reference. Ask the capital partner how many deals they have funded with this sponsor and what happened to the ones that did not fund. Ask what their own approval process requires and how long it takes. Then price the answer into the recommendation.
The second structural protection is to make exclusivity earn its keep. Exclusivity should be short, and it should be tied to milestones rather than to a calendar alone. Sixty days with an extension conditioned on delivering a signed debt commitment by day 30 is a very different instrument from ninety days with an automatic extension on request. The extension is where the leverage sits. A buyer who has performed gets one without argument. A buyer who has spent 30 days failing to assemble equity should be renegotiating for it, ideally while the underbidder is still reachable.
Keeping the underbidder reachable is the third protection and it is mostly a communications discipline. A second bidder who has been told nothing for eleven weeks is gone. A second bidder who received a courteous update in week four and another in week eight is a call away. That costs an advisor two emails and it is the only thing standing between a client and the extension conversation described at the top of this article.
I want to be careful about the claims here. The Cordis Institute Preparation Gap dataset (DOI 10.2139/ssrn.6515478) covers 89 lower middle market transactions and finds a post-LOI price adjustment in 68 percent of them, with median compression of 9.8 percent between the letter of intent and closing. That study measures price movement across the post-LOI window. It does not isolate buyer financing as the cause, and I will not claim it does. What it establishes is that the window after exclusivity is where value moves, and buyer-side funding uncertainty is one of the few inputs to that window an advisor can substantially resolve before it opens. The Buyer Lane Map (DOI 10.2139/ssrn.6735844) makes the related point that different buyer types impose different requirements on a seller, and capital structure is part of what distinguishes them. That is the same reasoning behind the buyer lane decision most advisors are not yet equipped to make and behind why most sellers pick the wrong buyer before diligence starts.
It also changes how competing offers should be scored. A bid from a committed fund with a signed debt commitment at 7.6 times and a bid from an unfunded sponsor at 8.4 times are not 800 basis points apart. They are two different probability distributions, and a responsible advisor presents them that way rather than as two numbers on a grid, which is the argument I made about scoring competing letters of intent when the highest bid is not the best offer. The same analysis applies with more urgency when a founder arrives holding an unsolicited offer, because an unsolicited bidder has faced no competitive pressure at all to demonstrate capacity.
Whether this workstream belongs to the advisor should also be written into the engagement letter rather than assumed, which is one more item on the list of things a seller should ask about before signing any engagement letter. Buyer financing verification is not expensive and it is not slow. It is four phone calls and a document request, and it is the highest return hour in the process.
The chemical distribution founder eventually closed, eleven months after he signed the first letter of intent, with a different buyer, at 7.7 times. He lost roughly 2.6 million dollars of enterprise value against the original headline and a year of his life, and none of it was because his company was not ready. It was because the only party in the transaction nobody diligenced was the one who had to produce the money. Preparing a business to withstand a buyer's examination is most of what we do for founders at Cordis Group. Examining the buyer back is the other half, and it is the half the market still treats as optional.