FAQs – Financial

There are three types of funding: conventional loans, SBA loans, and seller financing. 


  1. Conventional loans are the most common type of small businesses lending. They provide short-term, intermediate and long-term funding for companies. Rates and other terms differ between lenders and depend on the overall credit risk of the Buyer or business applying for the loan. 
  2. The Small Business Administration (“SBA”) offers a variety of loan programs to help small business owners obtain necessary financing to grow or purchase a business. The SBA doesn't lend money directly but instead provides conventional lenders with federal guarantees for loans that meet their guidelines. When you apply for an SBA loan, you will typically be borrowing from a bank or specialty financier. 
  3. Seller financing is when a Seller lends their Buyer a portion of the business purchase price. The Buyer and Seller will execute a promissory note outlining terms such as interest rate, repayment schedule and consequences of default. 

Working capital is the money available to meet a business’s current, short-term financial requirements. 


Some businesses don’t collect cash at the time of sale or service. In fact, many don't receive payment from customers until 30 days (or more) after the service or product is delivered. However, the business’s day-to-day bills such as rent, payroll, utilities, etc. must be paid on time, even if customer payments haven’t been received. Even businesses that get paid at the time of sale still need a healthy cash cushion to weather inevitable slow periods. 


Working capital is your safety net, as lack of free cash is the top reason businesses fail. Every business has different working capital requirements. The Seller, the Agent, or your accountant can help estimate the working capital requirements for your particular business.

The term is frequently used in two different ways.


  1. In accounting, goodwill is an intangible asset associated with a business purchase. Goodwill is recorded when a company acquires another business and the purchase price is greater than the fair value of the identifiable tangible and intangible assets acquired minus the liabilities that were assumed.
  2. Outside of accounting, goodwill more broadly refers to the value created within a company as a result of a competitive advantage, amazing customer service, history of profitability, excellent structure, unique management, etc. This type of goodwill is never explicitly recorded or reported on a balance sheet. In general, the better the target business has been built, the higher the goodwill component of the purchase price.

Seller's Discretionary Earnings ("SDE") is one method of measuring the total economic benefit a Buyer can expect to derive from a business. Generally, this is the sum of a business's net profits on its taxes, owner’s salary and benefits, any one-time business expenses, and any owner's expenses run through the company. SDE is the largest factor that influences the market value of the business.

 

SDE calculations should be handled by an experienced Agent. The math may seem simple at first glance, but there is a great deal of nuance knowing which expenses can be properly included in SDE. It takes an experienced broker to accurately recast the financial statements and calculate the correct SDE for a business.

EBITDA stands for Earnings, Before deducting for Interest, Taxes on income, Depreciation, and Amortization. It is another method to measure the total economic benefit a Buyer can expect to derive from the business. The EBITDA calculations are similar to the SDE calculations, however they typically treat the manager or owner's salary and benefits as a company expense, rather than adding it back as an economic benefit.

The market multiple applied to each valuation method is different, so you have to select one method and apply it consistently throughout the purchase process. It doesn’t work to calculate EBITDA (which is normally much less than SDE) and then apply a SDE multiple to value the business; this would result in purchase prices much lower than the market. Conversely, applying an EBIDTA market multiple to a SDE calculated business will result in a price it is much higher than the market. When calculated properly, EBITDA and SDE valuation methods are typically close in value. SDE is the more widely used valuation method for small business transactions, including by SBA lenders.  

 

The more practical way to decide between EBITDA or SDE is the nature of the business and the owner’s role in it. In most typical small business purchases, the owner is also an operator or active general manager of the business. In this situation, the buyer must consider the entire pot of benefits to the owner, and apportion them as money to live, benefits, loan service, and return on investment. In the sale of most small businesses, the buyers will be owner operators and the market price will be based on SDE. In larger business, with more tiered staffing and where the owner is not in an active managerial role, the Buyer is more often looking at the business as an investment. The better measure of the return on the investment in these circumstances tends to be EBITDA.

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