What Size Business Do You Need?
A fair number of would-be buyers come to us still in the midst of their careers, so they have been used to a certain income level for some time. They’ll tell us, “I need to make X,” and it’s almost never lower than their current salary. While we understand that perspective, let’s put that within the frame of a business transaction.
Look at the Numbers
There are some key numbers we need to consider when trying to calculate the X referred to above:
- Asking Price
- Cash Flow
- Debt Service
How do these numbers work together? Let’s use round numbers to make the math simple. Let’s say a business is asking $550,000 (and because they are one of our clients, they’ve gotten a professional valuation so that number is bankable) against annual cash flow of $200,000. Most SBA deals (and many of our deals involve SBA loans) require some kind of seller financing, which can bring down the total upfront amount. In this case, let’s say the seller is willing to finance 5%, or $27,500.
The bank is generally going to want to see at least 10% from the buyer, so with the $27,500 that the seller is willing to finance, the bank will want to see $52,250 from the buyer. That gets us to $470,250 that needs to be financed.
Let’s assume a 10% interest rate, which gets us $74,568 in annual debt service to the bank and the seller financing we’ll assume to be around $6,000 for a 5 year payback.
So if we subtract the debt service ($80,568) from the cash flow ($200,000), we get $119,432.
If our client’s X was $120,000, we’re there!(A buyer also needs to consider ongoing working capital requirements with their cash needs but most banks will supply a line of credit to handle 30-60 days of working capital.)
But what if our client’s X was $150,000? There are two ways to go.
The first is delayed gratification. Save your pennies for a few more years and come back with a larger down payment so we can get closer to your X.
The second is belt-tightening. Reduce your expenses now and see how you do for 3-6 months on a new budget that’s closer to the X that’s appropriate for the down payment you have in hand. Sometimes going forward means taking a couple steps to the side and even back.
Keep in mind too that our fictional scenario doesn’t account for individual tax situations. While owning a business is definitely more favorable than having a job in the US tax system, your accountant should be consulted when making these calculations. With all the advantages business owners have you may not be taxed as heavily, meaning you’ll get to take home more net pay than you might have compared to the exact same gross amount in a regular salaried job.
We hope this exercise helps you see that buying a business, like buying many other assets, involves more than one sticker price. Dive deeper to find out what size business you need to pay your bills while you build it and grow it.
Not sure if the market these days is tracking along with our fictional numbers above? Give us a call and find out what’s out there…before it’s gone!
