First-time buyers make the same due diligence mistakes repeatedly — not because they're careless, but because they don't know what they don't know. Here are the three red flags that most often surface in our deal review process, and how to evaluate each one.
Red Flag 1: Revenue That Doesn't Match the Tax Returns
The seller's P&L says $2.4M in revenue. The tax return says $1.9M. This gap is one of the most common issues in ecommerce acquisitions, and it's almost never an innocent discrepancy.
Common explanations:
- Add-backs presented as revenue. The seller included owner distributions, personal expenses, or one-time income in the top-line figure.
- Cash sales not reported. Some sellers, particularly in marketplace businesses, don't report all cash income on their returns.
- Returns and chargebacks not netted. Gross revenue looks bigger than net revenue. Make sure you're comparing apples to apples.
What to do: request IRS tax transcripts directly (your lender will do this during underwriting anyway) and reconcile every line. If there's a gap the seller can't explain cleanly, it's a deal-stopper.
Red Flag 2: Seller Is the Business
You're not just buying revenue — you're buying a system that generates revenue without requiring the seller. If that system doesn't exist, you're buying a job.
Ask these questions:
- Who handles customer service today? What happens if they leave?
- Who manages the ad account? Is that work documented anywhere?
- Who has the supplier relationships? Will those transfer to you?
- How many hours per week does the seller actually work in the business?
If the honest answer to most of these is "the seller," you need to price in the cost of replacing that labor — either by hiring, contracting, or budgeting your own time. A business that requires 30 hours/week of skilled operator time has a different value than one that runs on autopilot.
Red Flag 3: Trailing EBITDA Built on Cutting Costs, Not Growing Revenue
Sellers time their exits. It's rational. But one of the ways EBITDA gets inflated heading into a sale is by pulling back on investment — less ad spend, deferred inventory purchases, reduced headcount — while the revenue from prior investment continues to flow.
You'll see this pattern as:
- EBITDA margins that are unusually high in the trailing twelve months vs. prior years
- Ad spend as a percentage of revenue declining over the last 6–12 months
- Inventory levels that are lean relative to the business's growth rate
- A team that's been reduced but whose workload hasn't
Ask for monthly P&Ls going back 24–36 months. Plot ad spend, headcount costs, and EBITDA margin on a timeline. If the margin expansion coincides with obvious cost cuts, adjust your valuation accordingly.
A Framework for Weighting Risk
Not all red flags are deal-breakers. Some are pricing inputs. Ask yourself: if this risk materializes, what's the financial impact, and can I absorb it?
- Revenue discrepancy of 5%: negotiable. 20%: walk away.
- Seller dependency in one function: manageable. Seller dependency in every function: reprice or walk.
- Trailing margin inflation: model conservatively, offer accordingly.
The goal of diligence isn't to find a perfect business. It's to understand what you're actually buying.