Over the course of a search, an entrepreneur must become proficient at two different kinds of analysis: a broad initial screen of potential acquisition candidates and a deep dive into businesses that look most interesting. The online small business acquisition community tends to focus on the deep dive – it’s more technical, more time-consuming, and more expensive. However, analyzing a business as part of the initial broad screen is just as critical when it comes to executing a search. A buyer’s ability to manage their deal funnel and only perform deep dives on top acquisition candidates is a critical skill. This kind of analysis doesn’t reward deep and thorough technical analysis. Instead, searchers must make a number of decisions around what to examine further in a short period of time, usually with limited available information.
Fast business analysis skills for buyers
Time is extremely valuable, especially in the early stages of the process, so it is important to be able to quickly recognize positive characteristics as well as red flags the businesses have, to maximize efficiency. This article covers the most common elements of publicly listed deals and how to analyze them to determine whether a deeper dive is warranted. Deciding to pursue a deal will mean signing a Non-Disclosure Agreement with the business broker. Subsequently, the broker and seller will provide further information through the more detailed Confidential Information Memorandum (CIM).
Confidential Information Memorandum: This document essentially serves as a professional summary of the business, containing information such as financial performance, market position, assets, and operating history.
However, before a buyer gets to the CIM, they should be able to identify whether whether a business is worth pursuing based on a few characteristics presented in a listing or a public deal page.
Key deal features when analyzing a business listing
Though most buyers need to compromise a little when it comes to their location preferences, target location is helpful when it comes to narrowing down a search. Buyers may prioritize a location with a strong economy, a location with opportunity for their target industry, or possibly a location they find personally attractive.. Location decisions usually depend on each buyer’s personal situation, so there is no right or wrong answer.
This is a key measure of the size and reach of the business. While some listings will directly only provide one year of operating revenue, others may show a 3-year measure. If offered multiple years worth of data for revenue, a buyer should consider the trendline of operating revenue. Rapid decline in revenues could indicate trouble for the business while quick growth may indicate a temporary boost in performance designed to paint a brighter picture of the business.
Seller’s Discretionary Earnings (SDE)
The Seller Discretionary Earnings, SDE, of a business, is a measure buyers can use to compare businesses regardless of how an owner may take profit. It is more often used in evaluating smaller businesses, while EBITDA is used for larger businesses.
EBITDA stands for Earnings Before Interest, Taxes, Debt, and Amortization and is useful in valuing a business. Essentially, it is the measure of cash flow in a business and does not include the owner’s salary. Adjusted EBITDA is used to get a more accurate number through adjustments such as normalizing income and expenses.
The seller/broker determines the price of a business for sale. Comparing prices amongst other businesses in the industry brings out the value of this information.This is where buyers may find purchase multiples handy, which are found by dividing the SDE or EBITDA by price. The number is then compared with typical multiples from the industry to evaluate the business’s performance.
The description is one of the very first things a buyer will see when analyzing a business, and it provides details to contextualize the business. For instance, it may contain information regarding how dominant it is in a given area, years of operation, or the specific services it offers within an industry (ex: Remodeling kitchens in the Construction Services industry). A potential red flag would be mentions of a particularly large customer for the business, indicating concentration risk. This is important because heavy dependence on a particular group of customers could endanger the business if large customers leave once the current owner retires.
Reason for selling
The most common reasons for owners selling their business are retirement or health-related issues. Buyers may become skeptical of any other reasons such as wanting to pursue something else, as it may indicate something unattractive about the current venture.
Real estate/Leases/FF&E/Other assets
Some key questions a buyer will want to ask regarding real estate is whether or not a business owns or leases both their physical space as well as other key assets. Including owned capital assets and inventory may explain a higher price set by the seller, something buyers need to factor into the overall valuation model.
These are just some of the characteristics buyers should consider when analyzing a business as part of their search. While it may look like a challenging and complex process, the work will get easier with experience and practice. As they progress with their searches, most buyers will build internal methodologies that weigh some factors more heavily than others, depending on their preferences.
At Private Market Labs, our mission is to improve the way businesses are bought and sold so that more people can become successful buyers in this space. Follow us for more guides on how to acquire and run a profitable small business.