- In a business with a finance function you are testing systems; in a business without one you are testing a person, and the question is what happens when that person is no longer in it.
- Triangulate against sources the founder does not control: three years of monthly bank statements reconciled to reported revenue, tax returns against internal financials, payroll and sales tax filings, and supplier statements.
- The most productive founder question is what they tried to delegate that came back to them, because the reason it came back describes the exact dependency you are buying.
- A founder who has just been paid is a different person operationally, so a founder staying on moves transition risk out two or three years rather than removing it.
- Ask a departing founder to sort the top twenty relationships into those that transfer with a formal introduction and those that take years — founders are usually honest about this and nobody asks.
- Converting three years of cash-basis books to accrual frequently moves EBITDA and always moves the shape of the year, which is what the model and the working capital peg are built on.
The standard procedures return nothing, and this misleads people in both directions.
There is no monthly close package, so the request for one produces a spreadsheet assembled last week. There is no board pack, so the governance questions have no artifact to interrogate. The books are on cash basis or on an accrual basis maintained by a bookkeeper who learned the method from the founder. The customer list is accurate and lives in the founder's head; the version in the CRM is eleven months stale.
Buyers respond to this in one of two wrong ways. Some read the absence of infrastructure as an absence of controls and walk. Others read it as normal for the size and stop asking, which means they never establish what is actually true. Both mistakes come from applying a procedure designed for a company with a finance function to a company without one.
The right approach is to change what you are testing. In a business with a CFO you are testing systems. In a business without one you are testing a person, and the question is what happens to the business when that person is no longer in it.
Rebuild the numbers from outside the company
The internal records are not reliable enough to be the sole basis, so triangulate against sources the founder does not control.
Bank statements, three years, monthly. Deposits reconciled to reported revenue. This is tedious and it is the highest-confidence procedure available in this situation. Discrepancies are usually explicable and the explanations are informative.
Tax returns against the internal financials. Owner-operated businesses frequently have a gap here, often for legitimate reasons involving timing and elections. Ask for the reconciliation and read the accountant's workpapers if they can be obtained.
Sales tax filings, payroll filings, and any regulatory returns. Independent, periodic, and prepared for an audience with subpoena power.
Customer confirmations on the top accounts, where the process allows. Frequently deferred to confirmatory diligence for relationship reasons, which is understandable. Push for it earlier where you can.
Supplier statements. Payables in this kind of business are often understated by informal arrangements that never enter the ledger.
Establish what the founder is actually doing
The central question, and it takes structured conversation rather than documents.
- Walk me through last Tuesday, hour by hour. Concrete and hard to construct.
- Which customers will only speak to you? By name.
- What decisions cannot be made when you are on holiday, and how long can the business run without you before something breaks?
- Which suppliers give favourable terms because of you personally rather than because of the company's volume?
- What do you know about the business that is not written down anywhere?
- Who is second in each function, and what happens if you are unavailable for a month?
- What have you tried to delegate that came back to you, and why did it come back?
Question seven is the most productive. Every founder has tried to hand something off and had it fail, and the reason it failed usually describes the exact dependency you are buying.
If the founder is staying
The risk changes shape rather than disappearing. A founder who has just been paid is a different person operationally from one who has not, and the transition risk simply moves out two or three years.
- What is the earnout structure, and does it incentivise behaviour you want in years one and two? Earnouts tied to revenue in a business with thin controls invite the wrong decisions.
- What is the actual reporting line, and has the founder ever reported to anyone?
- What happens at the end of the employment term? Ask the founder directly what they intend to do, and note that the answer at this stage is not binding on anyone.
- Is there a non-compete, is it enforceable in the relevant jurisdiction, and does it cover the specific customer relationships rather than only the sector?
- Who is being hired to replace the founder's function, when, and out of whose budget?
If the founder is leaving
- What is the transition period, and is it in the purchase agreement or in a conversation?
- Which relationships transfer with a formal introduction and which require years? Get the founder to sort the top twenty into those buckets. Founders are usually honest about this and nobody asks.
- What is the retention plan for the layer below, and has anyone spoken to them? The second-tier team frequently learns about the sale at signing and their reaction is a material risk that is almost never diligenced.
- What did the founder pay themselves in cash and in kind, and what does the replacement cost? Usually more than the add-back schedule assumes, and usually more than one person.
The one about cash-basis books
A business on cash basis is not a business with bad books. It is a business whose books answer a different question than yours.
Convert three years to accrual yourself, or have it done. The specific things to look for: revenue recognised on collection rather than delivery, which distorts every month with a large order in it; expenses recognised on payment, which lets the December picture be managed; and working capital that cannot be assessed at all until the conversion is done, which matters because the peg is set off it.
The conversion frequently moves EBITDA. More importantly it moves the shape of the year, and the shape is what your model is built on.
What the absence of infrastructure is actually telling you
Sometimes it is a red flag. More often it is a description of the opportunity.
A business that has grown to $30 million of revenue and $6 million of EBITDA with no CFO, no ERP, and no formal sales process has done so on the strength of something real — a product position, a cost advantage, a set of relationships. The absence of infrastructure means that strength has never been amplified by any of it.
That is a legitimate thesis. It is also the most over-claimed thesis in the lower middle market, and the diligence question is whether the founder's involvement was the amplifier or the ceiling. Everything above is aimed at that one question, and it is the question the data room cannot answer.