Andrew Finn

Buying your first business is scary. You’re anxious to get in the game but you can’t afford to miss. You want to “buy a great business at a fair price”, but how do you know what a fair price is? Here's my guide to valuing any business. Especially your first! - 1. Your Goal You’re buying a business! People are going to look up to you! You're building generational wealth! And of course, you're going to be sooooo rich! Maybe. Right now, you only have 1 goal: Minimize your downside risk I know, “downside risk” isn't the sexiest thing to focus on but, with a purchase, things can go bad. How bad? - Lose your house - Declare bankruptcy - Significant reputational harm - Relationship problems with your spouse - Self confidence issues Not saying you can't bounce back. You can but our goal is to avoid this road at all costs. So be excited, dream big and create a compelling vision for yourself and your new company! But approach this process with due respect. 2. You aren't a fund Even if you’ve raised enough cash, you don't have a track record yet. Sure, you may have lots of operational “experience” (or whatever you said to convince people to give you money) but the reality is still the same. This is your first business. Go into the valuation process skeptical and paranoid. Avoid phrases like “synergies” or “vertical integration” or “operational efficiencies”. You don't have any of those yet. Underwrite the business based on its current state. Not what it did 3 years ago. Not what you think you can do. What it's doing right now. On your next purchase, after you've proven what you can do, go for it! But on this, your first, don't play with fire. Look at the business as it is. 3. Multiples don't matter Throw out EVERYTHING you've ever heard about multiples! “But that's what everyone uses! How can I just throw it out??!” Listen, multiples represent what other people have paid (past tense) for a business in your (preferred) industry. Only two types of buyers use multiples to set the purchase price: ⏺️ Sophisticated Industry Operators ⏺️ Idiots You aren't a Sophisticated Industry Operator yet and you sure as heck don't want to be an idiot! We don't care about what other people paid. We care about what you can pay. So set the price based on what the business can reasonably support. 4. What does matter Cash Flows There are 3 basic parts: ⏺️ Money Inflows (Revenue - Known) ⏺️ Money Outflows (Expenses - Known) ⏺️ Your new debt obligation (Debt - TBD) Cash Flows = Revenue - Operating Expenses - Debt Payments Here are a few of the many proxies for Cash Flows: - EBITDA - NOI - Profit - Taxable Income Identifying the best proxy for this specific business is THE most important step in the process. You will use this number to base your proforma and valuation off of. Don't be prideful here. Find a CPA, financial whiz, mentor or investor to help you calculate the right number. Start by answering these two questions: QUESTION #1 How would the business perform if I took over today? You don't care what it did a year or two ago. You only care what it's doing right now! **A note on seasonal businesses** What if the business is seasonal and how would I know that? If more than 30% of sales happen within a certain month or 60% of sales happen within a certain quarter then you have a seasonal business. Not the end of the world but something you need to fully understand. If their busy season happened in the last 6 months then you can proceed. If it happened longer than 6 months ago, WAIT and see how they do! Continue your process with the seller but set the close date for AFTER you see how they do. QUESTION #2 With the current owner gone, Is there anything I need to cut or add? Owner perks are a thing! Identify anything the previous owner is running through the business and evaluate it. At the same time, dig in to understand what the owner is currently doing. I have yet to see a deal in the SMB space where the owner was truly hands off. They are always playing some role. 5. Set your Value You have your Cash Flow number. Now, let's assign a value range. Assuming you are already working with a bank, gather this information: ⏺️Loan rate ⏺️Loan Term ⏺️Loan Amortization period ⏺️Your Debt Service Coverage Ratio (DSCR)* range ⏺️Cash down requirement ⏺️Your preferred Cash down DSCR Most banks will lend at a 1.2 DSCR but this is too slim for you as a first time buyer. There is very little cushion. Model your proforma off of at least 1.6 DSCR. Here’s why. Have you ever heard of the J-Curve? The basic theory is simple. Buying a business is expensive and takes an initial injection of capital to fund. At the same time, performance will slip. Revenue and profit will drop as you and your new team spend time building relationships. This is normal but means less time selling or on operations. As a result, your margin and cash position will drop. You will eventually recover your cash position but it will take time. If you plot this cash position over this time, it drops, then recovers and looks like a “J”. Hence the name. Like this: Cash drops from $350k down to $56k over the first quarter. ⏺️ $292k down to buy the business ⏺️~ -$1k in Cash Flows This is modeled off of a 1.6 DSCR. Are you comfortable with a $56k cushion? The Model Once you’ve done all of the work above, let's plug it in! This is the tool I use to set my range of comfortable valuations. Here is a screenshot It's an easy process: Step 1. Enter Purchase Price, your Cash Flow Proxy, Step 2. Enter loan Term, Amortization Period and Rate Step 3. Enter the your DSCR range (max 1.2) Step 4. Evaluate your Returns and iterate - TLDR; Your main goal is to minimize your downside risk You aren't a fund Multiples don't matter Cash Flow is all that matters Base your valuation off of Cash Flow I hope this helps and if you have any questions, leave them below.