Unless Salesforce is buying Slack, most SMB acquisitions must meet basic guidelines to be worthwhile. In very simple terms, all deals should:
- Provide the buyer with an income that satisfies their personal needs and will cover their mortgage, insurance, and all living expenses. This is important to both the buyer and the lender, unless the buyer has outside sources of income and doesn’t need the income from the acquisition.
- Have cash flow sufficient to service the debt used to acquire the business, plus another 30 percent or so cushion.
- Provide for a return on the buyer’s investment commensurate with the risk involved.
This is not to say that deals are not completed for companies that lose money and are purchased for their asset value, or even a synergistic value for the acquiring company. But in general, most deals need to address these basic needs.
Let’s look at a recent transaction, break it down, and see if it meets these criteria.
Company: ABC Company provides surveillance systems and camera services for casinos throughout the US. ABC has been established for 24 years and is owned entirely by its founder. They have approximately 50 clients in total, as there are a limited number of casino operators. But ABC is the industry leader, well respected, and enjoys positive relationships with most casino operators.
Revenue and Profits:
2023 2024 2025
Revenue $4.2MM $4.6MM $4.65MM
EBITDA $986K $1.1MM $1.2MM
EBITDA is clean, the company is fully staffed, including a General Manager who runs the company and is well paid, earning $275k annually plus benefits. Working capital required is $500k.
Deal Terms:
$4,000,000 total purchase price, no seller notes, all cash to seller at closing
SBA 7A Loan Details:
$4,000,000 purchase price
$500,000 working capital provided between the 7a loan and line of credit
$135,000 of costs, including SBA loan guarantee fees, appraisals, and other soft costs
$4,635,000 total project costs
$700,000 buyer equity injection/down payment. (Approximately 15% of total project costs)
$3,935,000 Total Loan amount paid over 10 years/8.75% interest (Prime plus 2)
$49.316.18 monthly principal and interest, $591,794 annual debt service.
Justification for Purchase Test:
Last full year EBITDA $1,200,000
Allowance for Owner Salary $150,000 (Although he could replace Manager)
Allowance for Taxes $175,000
Cash Flow Available for Debt Service $875,000
Actual Debt Service $591,794
Debt Service Coverage Ratio 1.48
This leaves $283,000 leftover to cover CapEx and provides for a return on the buyer’s equity injection.
On the surface, this deal seems to make sense and would meet SBA lender requirements. Obviously, a slightly better interest rate creates more free cash flow; conversely, if a buyer needed to pull a higher salary, that would create less cash flow. In this case, given that the company was fully managed, the EBITDA was correct, and the buyer wanted to assume the role of general manager, the current management’s salary would be added back to earnings. Or, if the buyer kept the manager, a reasonable assumption would be that the new owner would be able to lower overall labor costs or drive revenues and profits higher because of the new owner’s involvement.
The bottom line is that there are many variables at play, and each business and buyer is unique. But at a very high level, this deal seems to make sense.
