When considering buying a business that is listed for sale, one of the first things you need to evaluate is what size segment a business is in. Knowing some key information about how to value a business is quite helpful. Why is this important? A few reasons...to focus on the financial resources you may need in order to complete an acquisition. Another is to determine what type of resources and assistance you may need in order to make it happen. The paths of resources and acquiring an existing business are very different depending on what size segment you are in.
Beginning with “Main Street” businesses for sale, you will find prices that correspond to their lower revenue levels, under $1 or $2 million. This size segment of the market of businesses for sale has its own common valuation approach that is built around understanding what is often called “Seller’s Discretionary Earnings” or “Seller’s Discretionary Cash Flow” (SDE or SDCF). SDE is a shorthand way of expressing the owner’s compensation as the combination of salary plus depreciation charges plus any profit. A value can be derived by applying market-based multiple to SDE. These small businesses for sale often have weak and riskier cash flow characteristics, yet the competition with other buyers is higher, so let’s avoid that in your pursuit of companies for sale.
Moving up the size segment scale, something changes at about $2 million. The valuation method is different and is based not on SDE, but Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA). In the business valuation range between $2 million to $100 million or more we find the “Middle Market”. Here, the individual entrepreneur is not going to be able to compete to acquire a business for sale in almost all of this segment simply due to the constraints of their personal capital and/or debt financing of the magnitude required. But there is a sweet spot within that size segment – “Lower Middle Market” – that deserves attention.
Consider the businesses for sale in the subset of the Middle Market of the range between $2 million and $5 million – the Lower Middle Market. In this size segment, the capital structure can be within your reach if you are a seasoned manager with an entrepreneurial bent and some capital. Here we can blend personal cash with bank and seller financing to bring together enough capital to acquire a real asset, one that will pay a salary to the owner and still generate enough profit to service the debt and reinvest in its growth to create significant long term value.
It turns out that businesses with around $2 million to maybe $20 million in revenues will value in the Lower Middle Market size segment, so that’s the quick and easy first number to find to see if you are looking at the right kind of business opportunity.
To understand what size range of business for sale is within your reach, download the free “Business Buying-Power Calculator” here.