Inadequate Seller's Discretionary Earnings (SDE) When Selling a Business
In Issue #56, we discussed the number one obstacle to the successful sale of a business – the Business Owner’s Failure to Plan for a Sale. This issue will discuss the very common obstacle of Inadequate Seller’s Discretionary Earnings (SDE).
"Business without profit is not business any more than a pickle is candy." Charles F. Abbott
Inadequate Seller's Discretionary Earnings (SDE) When Selling a Business
Most small businesses are valued as a multiple of Seller’s Discretionary Earnings (SDE). In Issue #6, we briefly defined SDE as the net income (or net loss) on the company tax return + interest expense + depreciation expense + amortization expense + the current owner’s salary + owner’s perks. (CAUTION: as indicated in Issue #6, there are many other factors that might affect the calculation of SDE.) It would be a good time to re-read Issue #6 – How Small Businesses Are Valued Based on Seller’s Discretionary Earnings (SDE).
Inadequate seller’s discretionary earnings (below $100,000) is a major obstacle to the successful sale of a business.
Most buyers are looking for six-figure income potential
To justify the investment to acquire a business, most prospective business buyers need to pay themselves a reasonable salary for their efforts in running the business. The pool of buyers looking for the potential to make six figures ($100,000+) is huge, which creates demand in excess of supply, ultimately leading to higher multiples to maximize business valuations. For a prospective buyer to pay himself close to a $100,000 salary (after debt service on the acquisition), he’d have to acquire a business with Seller’s Discretionary Earnings of about $150,000 at an acquisition price of approximately $375,000 to $450,000. (CAUTION: The above are general numbers that may not apply to all industries or situations).
Seller's Discretionary Earnings below $100,000 is a major obstacle
Most of the time, if other obstacles are not significant, businesses with Seller’s Discretionary Earnings between $100,000 and $150,000 in SDE can be sold. As SDE decreases from $100,000, so does the likelihood of a successful sale. If SDE is below $75,000, the likelihood of a successful sale is greatly diminished.
In today’s business climate, obtaining lender financing for business acquisitions that have less than $100,000 in SDE is extremely difficult. For more information, read this article: Issue #61 – Business Acquisitions that Cannot be Financed.
Seller's Discretionary Earnings above $150,000 significantly improves salability
Here’s the bottom line: …….
