Deal structures, asset versus stock purchases, earnouts and seller notes, accretion and dilution, quality of earnings, and a diligence checklist.
Mergers and acquisitions is the buying, selling and combining of companies. The work splits across a few roles. Sell-side advisors (investment banks, M&A advisors, business brokers) market a company and run a process. Buy-side teams (corporate development, private equity, search funds, independent sponsors) find, value and finance targets. Lenders underwrite debt; lawyers draft the agreements; accountants test the numbers. In a small deal, one person often plays several of these roles.
Related: valuation, LBO modeling, career paths, the glossary, the M&A interview questions, and the community guides. Numbers are illustrative unless a source is named.
| Stage | What happens | Your output |
|---|---|---|
| 1. Sourcing | Find targets: direct outreach, brokers, networks, databases | Target list, call log |
| 2. NDA and first look | Sign a confidentiality agreement; receive a teaser or confidential information memorandum (CIM) | Initial model, screening memo |
| 3. Indication of interest | Non-binding price range and structure, often in a broker-run process | Valuation range |
| 4. Letter of intent (LOI) | Price, structure, exclusivity period, timeline | Negotiated LOI |
| 5. Diligence and financing | Financial, customer, legal, tax, operations; lender underwriting | QoE, lender approval, final model |
| 6. Definitive agreement | Asset purchase agreement or equity purchase agreement, disclosure schedules | Signed agreement |
| 7. Closing | Funds flow, assignments, bank accounts, insurance, employee transition | Closing statement, funds flow |
| 8. First 100 days | Customer calls, staff meetings, reporting, working capital true-up | Operating plan |
Time frames vary. The Stanford 2024 search fund study reports that searchers signed an average of 3.6 letters of intent, the first about 7.8 months into the search, and lists discoveries in diligence, seller retraction, lack of investor support and valuation among the reasons LOIs fail. Expect many deals to die between LOI and closing, which is why you keep a pipeline.
| Asset purchase | Equity (stock or membership interest) purchase | Merger | |
|---|---|---|---|
| What you buy | Selected assets and assumed liabilities | The ownership of the entity | The entity combines with another by law |
| Liabilities | Only those you assume | All, known and unknown | All, passed to the survivor |
| Tax basis | Stepped up to the price paid; goodwill generally amortized over 15 years (IRS section 197) | Generally carryover basis | Depends on structure |
| Contracts and permits | Often need assignment or consent | Stay with the entity (check change-of-control clauses) | Depends on the law |
| Paperwork | Allocation of price on IRS Form 8594 | Share or interest transfer documents | Plan of merger, filings |
| Typical in small deals | Very common | Common when permits or contracts are hard to move | Larger and public deals |
In an asset deal the buyer and seller each report the purchase price allocation on Form 8594 using the residual method: assets are classified into seven classes from cash through goodwill and going concern value, which takes whatever price remains. The allocation matters because it determines depreciation and the seller's tax character, so the two sides negotiate it. Have a tax advisor review the structure before the LOI.
Have an experienced M&A attorney draft and negotiate these. The Stanford Primer includes legal template exhibits contributed by law firms, which are a useful start for understanding documents, not a substitute for counsel.
When a company buys another, the question is whether earnings per share (EPS) rise (accretion) or fall (dilution). The method:
Pro forma net income = Buyer net income + Target net income
- after-tax financing cost (interest on new debt or lost interest on cash)
- after-tax extra D&A from asset write-ups
+ after-tax synergies
Pro forma shares = Buyer shares + new shares issued
Pro forma EPS = Pro forma net income / Pro forma shares
Accretive if pro forma EPS > buyer's standalone EPSIllustrative example (invented, $ millions except per share; no synergies, no purchase accounting):
| Buyer | Target | |
|---|---|---|
| Net income | 100 | 20 |
| Shares outstanding | 50 | |
| Share price | $40 | |
| EPS and P/E | $2.00, 20x | Purchase price 300, P/E 15x |
For small private buyers EPS is rarely the issue; the equivalent question is whether the deal raises cash flow per dollar invested, which the LBO model answers.
A quality of earnings (QoE) report tests whether the earnings the seller presents are real and repeatable. SBA SOP 50 10 8.1 describes what the lender requires for initial acquisitions with a purchase price of $3M or more:
If you commission your own QoE before approaching a lender, the SOP says the lender may have an approved vendor review it. Ask the lender before you spend money.
| Workstream | Request | Look for |
|---|---|---|
| Financial | QoE, monthly P&L and balance sheet, tax returns, bank statements, cash proof, working capital, debt and liabilities, capex history | Add-backs, seasonality, cash versus accrual, deferred revenue |
| Customers | Revenue by customer and cohort, contracts, renewals, calls with top customers, churn | Concentration, price increases that will not stick, customers tied to the owner |
| Legal | Entity documents, contracts, leases, litigation, licenses and permits, intellectual property, assignment clauses | Consent requirements, pending claims, expired licenses |
| Tax | Federal, state and sales tax filings, payroll tax, structure | Unpaid payroll or sales tax, structure that loses the step-up |
| Operations and people | Org chart, key employee agreements, payroll, benefits, systems, vendors | Key-person dependence, wage inflation, informal pay arrangements |
| Insurance and risk | Policies, claims history, workers compensation, safety record | Gaps in coverage |
| Real estate and environmental | Lease or deed, appraisal, environmental reports where relevant | Related-party leases at off-market rent |
| Lender | Valuation, QoE, collateral, guaranties, standby agreements | Gaps between price and valuation |
Keep a request list with owner, date requested, date received and status. Tie every finding to a model change or a price, structure or covenant change. A finding without a decision is a loose end.
Details and a numeric example are on LBO Modeling for Small Deals. Check the current SOP before quoting; SBA changes its rules, and version 8.1 took effect on October 1, 2026.
From Stanford's 2026 Primer and 2024 Study: a searcher raises search capital (a median of $500K) from investors, searches for about two years, signs an LOI, then asks the same investors to fund the acquisition. The search capital converts into acquisition equity at a step-up, often 150%. Many funds now raise acquisition capital of $5M to $10M per the Primer. The investors usually get participating preferred equity; the searcher earns up to 25% to 30% of the common equity in three tranches. The median number of investors in a core search fund acquisition was 16: 12 from the original search and four new at the time of acquisition. After closing, the searcher becomes CEO and reports to a board of investors.
1. Parties and the business being acquired 2. Purchase price, with working capital assumption (cash-free, debt-free) 3. Form of consideration: cash, seller note (amount, rate, term, standby), earnout, rollover 4. Structure: asset or equity purchase 5. Financing condition (SBA or other lender) and equity sources 6. Diligence scope and timeline: financial, customer, legal, tax, QoE 7. Seller transition: role, term, compensation, non-compete 8. Exclusivity: number of days, no shopping the deal 9. Confidentiality (reference the NDA) 10. Non-binding statement, except confidentiality and exclusivity 11. Expected timeline to definitive agreement and closing 12. Signature blocks
The Stanford study reports sellers staying engaged for six months after closing and over 90% of searchers reporting a positive relationship with sellers after the transaction.
Using the $5.05M sources and uses from the LBO page(invented figures). The seller owes $220K to a bank that must be paid off at closing, and $150K of the price goes into escrow for 12 months.
| Sources of cash | $ | Uses of cash | $ |
|---|---|---|---|
| SBA 7(a) loan | 4,545,000 | Cash to seller | 3,877,500 |
| Buyer equity | 252,500 | Payoff of seller's bank debt | 220,000 |
| Escrow agent (indemnity holdback) | 150,000 | ||
| Transaction costs | 300,000 | ||
| Cash to the company's bank account | 250,000 | ||
| Total cash | 4,797,500 | Total cash | 4,797,500 |
The purchase price of $4,500,000 is satisfied by cash to the seller ($3,877,500), the payoff of debt ($220,000), the escrow ($150,000) and the seller note ($252,500, a non-cash credit): 3,877,500 + 220,000 + 150,000 + 252,500 = 4,500,000. The $5.05M of total uses is the price plus costs and cash to the balance sheet. Funds flow memos go to the lender, the escrow agent and counsel for sign-off the day before closing.
The peg is $600K. At closing, estimated working capital is $600K. Ninety days later the final closing balance sheet shows $640K. The buyer received $40K more working capital than the agreement priced, so the buyer pays the seller $40K. If it had shown $565K, the seller would pay the buyer $35K. The agreement should state the accounting method, the definition of included accounts, the dispute process and a deadline.
The seller can earn an additional $300K if revenue from the top customer is at least $1.2M in year 2. Buyer's estimate: 60% probability. Expected payment $180K, discounted two years at 10%: 180,000 / 1.21 = about $148,760. Model it as a debt-like payment in year 2 and test coverage that year, so the earnout cannot push the business below the lender's covenant.
Deal-structure and diligence guidance in this chapter is general professional practice, not legal or tax advice. Use qualified counsel and accountants for any transaction.
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Longer written answers live in the community guides.