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  • Writer's pictureEric Williams

Does your business earn enough to attract a buyer?

A common misconception of business sellers is that if a business has a low price because there is a corresponding low level of Seller Discretionary Earnings (Earnings Before Interest Taxes Depreciation and Amortization plus the expensed wages of one owner) it will be easier to sell given that more buyers will be able to put together the capital necessary to acquire it.

Unfortunately, there are other factors that tend to outweigh the low price. Most individuals who are sophisticated enough to be comfortable acquiring a business, and who have the financial wherewithal to complete an acquisition, are also able to earn high salaries working for someone else. Most of the acquirers that Codiligent has worked with would be able to command salaries of $120,000-$200,000+ a year working for someone else. So, the challenge is that if someone is able to earn $120,000+ a year working for someone else without the expense and risk of business ownership, it is hard to justify paying for a business in which they will earn a similar amount of money.

For example, if an acquirer could make $120,000 working for someone else, but was looking at a business valued at $320,000 which was generating $130,000 of Seller Discretionary Earnings, their remaining cash flow beyond a market rate of compensation for their labor would only be $10,000. This would represent a meager 3% annual return on their $320,000 investment. You might think "what about their wage of $120,000? Isn't that part of their return?" Not really if they will need to work full-time in the business - people don't usually pay for a job.

With companies that are looking to buy another business as a strategic acquisition, the challenge is often that after paying someone to run the business there will be too little cash flow remaining to justify devoting the time, attention, and resources to the acquisition unless they have a way to significantly increase cash flow, and even then it still may make more sense for them to leverage their time, energy, and resources on a larger alternate transaction.

There are reasons a buyer may still be interested in a smaller acquisition, for example: an individual may buy a company for lifestyle, opportunities for growth, because they are passionate about the type of business, or they desire to live in the location of the business. Perhaps a strategic buyer may be able to cross-sell the target company's products or services, may gain a new technology or R&D, or might gain client relationships or some other advantage. However, businesses with more than $300,000 in re-cast Seller Discretionary Earnings will be more marketable than those with lower Seller Discretionary Earnings, and businesses tend to become significantly more marketable when they have cash flow in excess of $1 million.


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