Just because a business is affordable, doesn’t make it the right buy.
So how do you spot the RIGHT profitable business?
This is why having a well-defined deal box is so critical.
Let’s go through each stage of the Acquisitions Deal Decision Tree to simplify the process!
Stage 1
My Rough Process: The numbers matter - Get 3 to 5 years of financial statements.
→You won’t always get a clean Profit & Loss Statement (P&L)
→that doesn’t mean it’s not a good business - budget for a book keeper
→Taxes tell the story pretty well...
→I reformat tax forms into side-by-side P&Ls for 1000ft view.
Quickly check high level numbers: Revenue, COGS, gross margins, expenses sum, net profits and margins.
→Run back through and add up EBITDA.
→“Add back” reasonable items for Seller’s Discretionary Earnings (SDE) - while it’s not exactly “cash flow” it’s getting close.
→The easiest rough SDE figure will be EBITDA + Seller’s Salary
→(I don't count distributions - ask me why below)
If you worked on your deal box from my last post - you’ll know if the financials are even close to hitting the mark by now.
→If it doesn’t pass the first test - I don’t waste my time.
→Breaking down SDE accurately takes time and experience.
On my first deal I stared at the numbers for much longer than I do now, and that’s ok - I got faster at assessing deals with time and reps.
This is just Stage 1 of finding the RIGHT deal:
I'll keep breaking down the steps and dive deeper in my next newsletter on going after "Bad Deals" and how to keep moving.
Stage 2
Stage 2 of finding a good business goes beyond financial statements and looks closer at the industry, market, and trends of the business.
Good signs:
→Stable to rising sales?
→Stable to rising gross margins?
→Stable to rising SDE/NOI/EBITDA?
→Is it in a good market/location?
Red flags:
→Gross defects in the business - e.g.:
→Net operating loss (NOL)
→Debt/Equity < 1
→Dry cleaner with toxic chemical history
→Franchisor has Right of First Refusal on the business/location
If it fails any of these checks, it’s a sign you should pass.
As a new owner, you want every possible advantage when you walk into a new business. The RIGHT deal is out there if you’re careful and patient.
Stage 3
Stage 3: Is the asking price reasonable?
For small businesses (where we focus), a multiple of SDE is most common unlike commercial real estate where it is the Cap Rate.
The range of multiples can be anywhere from a low 1.2X or driven higher (4X or more) by several factors:
→Is there an operator in place ?
→Does this business have an absentee owner ?
→Is it a popular asset class? (Does the multiple reflect that industry average?) →Does the business have significant recurring revenue and stable contracts? …and much more.
If there’s real estate involved in the deal you’ll need to be aware of both valuation methods:
→Cap rate > Loan Rate + 1%?
→Is Cash Flow (after debt service) right for you ?
→Is the Debt Coverage (DSCR) above your threshold >1.5 ?
→Will the seller budge on price or rates to improve cash flow?
When it fails this check and the seller won't move, give it time and stay in contact.
The RIGHT deal is negotiable - often sellers will have high expectations for the sale price of the business and aligning them with reality can take some time.
Apply your strongest leverage by carefully evaluating and using multiples to negotiate a fair price.
Stage 4
Stage 4: Good terms/structure?
Terms make the deal. If you can control the terms of an acquisition you have the biggest impact on cash flow and best leverage to mitigate risk.
Mitigate your risk by including contingencies on key operators, licenses, contracts, and exclusivity until closing:
→Seller Carry 10%
(or more to incentivize post-sale engagement and unknown risks)
→Low interest rate on carry
→Can you fund the deal without a Personal Guarantee?
→Real Estate or ensure Lease is transferrable without raising rates
→Earnouts for the seller (or forgivable notes when using SBA)
→Is Working Capital or AR included? (You normally pay more for this)
Good Terms can also help you avoid:
→Negative Capitalization (Large amounts of AP on balance sheet)
→Dangerous Debt terms
The RIGHT business will have great terms along with a fair price - terms ultimately control the cost of the acquisition and the financial risk to you.
If you’ve passed all your checks at this point GET IT *UNDER CONTRACT!
To get 1 on 1 help assessing deals, defining your deal box, and finding the RIGHT business - sign up for personal acquisition coaching with me, right here!
For $1000 you’ll get a full month of direct support and assistance to buy the RIGHT business and establish your legacy of financial freedom!