What Are the Red Flags When Buying a Business?
By Troy Frank, Owner — Indiana Equity Brokers
Estimated read time: 7 min
The short answer: The most serious red flags when buying a business are owner dependency, customer concentration above 30% of revenue, financials that don’t reconcile to the tax returns, margins that have quietly declined for two or three years, and a seller who can’t give a straight answer about why they’re selling. None of these automatically kill a deal — every business has something. What matters is whether the seller volunteers it or you have to find it. A problem disclosed is a problem you can price. A problem discovered is usually a reason to walk.
Most buyers I meet are looking for reasons to say yes. That’s the wrong job.
By the time someone sits across from me with a signed NDA, they’ve already pictured themselves running the place. Excitement is fine. But the buyers who do well in Indiana are the ones who spend the first two weeks actively hunting for the reason not to buy. If they can’t find one, they’ve bought well. If they find one and it’s fixable, they’ve got leverage.
Over 24 years and more than 880 closed transactions, the same warning signs keep showing up. Here are the ones that actually matter — and the ones that scare buyers off for no good reason.
Red Flag 1: The Business Is the Owner
This is the one buyers underestimate most.
Ask a simple question: what happens to revenue if the seller disappears tomorrow? If the honest answer is “it drops by half,” you aren’t buying a business. You’re buying a job with a seller’s name on the customer relationships.
The tells are easy to spot once you look. The owner holds every key customer relationship personally. Pricing decisions live in their head, not in a system. There’s no second-in-command who could run a week without them. The owner works 60 hours and the business has no manager layer at all.
This doesn’t mean walk. It means structure differently. A longer transition period, a meaningful seller note, or an earnout tied to customer retention all shift risk back to the person who created it. What you don’t do is pay a full multiple for goodwill that’s about to leave the building.
Red Flag 2: Too Much Revenue From Too Few Customers
Customer concentration is the risk that shows up in every lender conversation. As a working rule, if one customer is more than 30% of revenue, treat it as a material issue. If your top three are over 50%, treat it as the central issue in the deal.
Then go one level deeper, because the percentage isn’t the whole story. Ask how long that customer has been there. Ask whether there’s a written contract or just a long habit. Ask whose relationship it actually is — the company’s, or the owner’s. A 40% customer under a three-year contract with a purchasing department is a very different risk than a 40% customer who golfs with the seller.
Lenders will ask the same questions. If concentration is heavy enough, an SBA lender may reduce what they’ll finance or decline the deal outright, which means this can end your acquisition before you ever get to negotiate.
Red Flag 3: The Numbers Don’t Reconcile
This is the flag that ends deals fastest, and it’s the easiest to test.
Line up three years of tax returns next to three years of internal profit and loss statements. They should tell the same story. When the P&L shows $600,000 of profit and the tax return shows $200,000, you need an explanation, and “we run some things through the business” is not one — at least not without documentation.
Every add-back needs a receipt. The owner’s personal vehicle, the family phone plan, the one-time legal settlement, the above-market rent paid to the owner’s own building — all legitimate adjustments, all things a buyer and a lender will want proof of. Add-backs you can document survive underwriting. Add-backs built on the seller’s word get stripped out, and the price comes down with them.
Bank statements are the tiebreaker. Deposits should track revenue. When they don’t, stop and find out why before you spend another dollar on diligence. This is exactly the kind of thing that surfaces during the due diligence weeks after an offer is accepted — and it’s much cheaper to catch it now.
Red Flag 4: A Slow, Unexplained Decline
Buyers focus hard on last year’s number. The trend matters more.
Pull five years if you can get it, three at minimum, and look at gross margin as a percentage rather than dollars. Revenue can hold flat while margin quietly erodes — that’s a business absorbing cost increases it can’t pass through, and it’s a much worse sign than a single soft year.
Watch for deferred maintenance too. Equipment nobody replaced. A truck fleet with 300,000 miles on it. Software the industry moved past four years ago. That’s real capital you’ll spend in year one, and it belongs in your valuation, not in your surprise column.
An owner who decided to sell three years ago and stopped investing leaves a very specific fingerprint. It’s usually visible in the fixed asset schedule.
Red Flag 5: The Seller Can’t Explain Why They’re Selling
Retirement, health, partner dispute, burnout, a move — all normal. Sellers who give you a clear reason and a consistent story are telling you the truth.
The concern is the vague answer. “Ready for a new challenge” from a 46-year-old with no next act tends to mean something else is coming: a lease that won’t renew, a franchise agreement expiring, a big customer that already gave notice, a regulation about to change, or a competitor moving in down the road.
Ask directly. Ask twice, at different points in the process. Then check the answer against the numbers.
What Isn’t a Red Flag
Some things scare buyers off that shouldn’t.
Messy bookkeeping is not the same as dishonest bookkeeping. A lot of good Indiana businesses are run by owners who are excellent operators and indifferent accountants. If the underlying numbers hold up when you rebuild them, disorganization is a discount opportunity, not a disqualifier.
An unglamorous industry is not a red flag either. Some of the best cash flow I’ve sold came out of businesses nobody would brag about at a dinner party.
And a seller who wants to stay involved isn’t automatically a problem. Sometimes that’s exactly what you want, as long as the terms are written down.
The real distinction is disclosure. Sellers who put their problems on the table early are usually telling you the truth about everything else. That’s the pattern I’d watch above any single metric. If you want the full framework, we’ve written a longer piece on how to evaluate a business before you buy it.
Frequently Asked Questions
What are the biggest red flags when buying a small business?
Owner dependency, customer concentration above 30% of revenue, financials that don’t reconcile to tax returns, gross margins declining over several years, and a seller who can’t clearly explain why they’re selling. Undisclosed litigation and deferred equipment maintenance round out the list.
How much customer concentration is too much when buying a business?
A single customer above 30% of revenue is a material risk, and a top three above 50% should reshape how you structure the deal. What matters as much as the percentage is whether the relationship is contracted, how long it has lasted, and whether it belongs to the company or to the departing owner.
What if the seller’s books don’t match their tax returns?
Stop and get an explanation before spending more on diligence. Legitimate add-backs — an owner’s vehicle, personal phone, one-time expenses, above-market owner rent — explain most gaps, but each one needs documentation. Undocumented add-backs get removed during lender underwriting, which lowers both the valuation and the loan amount.
Should I walk away from a business that depends heavily on the owner?
Not necessarily. Owner dependency is a structuring problem more than a disqualifier. A longer transition, a larger seller note, or an earnout tied to customer retention keeps the seller invested in the handoff. The mistake is paying a full multiple for goodwill that walks out the door at closing.
Is messy bookkeeping a reason not to buy a business?
Usually not. Many well-run small businesses have disorganized records simply because the owner is an operator, not an accountant. If the underlying numbers hold up when reconstructed against bank statements and tax returns, poor bookkeeping is often a negotiating advantage rather than a warning sign.
How do I check for red flags before making an offer?
Review three to five years of tax returns and P&Ls side by side, request a customer revenue breakdown, ask what happens to revenue without the owner, examine the fixed asset schedule for deferred maintenance, and ask the reason for selling more than once. A broker representing the listing can supply most of this before you commit to an offer.
The Buyers Who Do Best Ask Harder Questions
Every business has something. Twenty-four years in, I’ve never taken a company to market that was flawless. The buyers who do well aren’t the ones who find a perfect business — they’re the ones who find the problems early, price them accurately, and structure around them.
If you’re looking at Indiana businesses now, it costs nothing to have a conversation about what you’re seeing. You can browse our current business listings or read more about how we work with buyers.
Reach me directly at troy@indianaequitybrokers.com or visit indianaequitybrokers.com.
