Been getting the 'how do you buy a portfolio of micro SMBs?' question a lot recently, esp from 1st time searchers. My answer: simple math makes it hard, but if you can play the long game, it gets easier. (math below is rounded + TONS of assumptions = keeping it simple)
$500k SDE x 3.5 SDE multiple = $1.75M purchase price. Using 90% SBA loan (ignore seller note) = $1.575M loan @ 5% = $200k/year debt service. So, $500k SDE = $300k of FCF after debt service.
But SDE means FCF before paying the owner's comp...what if he/she (seller) was active? Then adjust the post debt service FCF for his/her replacement...which is probably you (buyer). How much is that adjustment? Depends, but let's say $125k/year.
Now FCF is $175k/year before CapEx, NWC buildup, etc.
FCF is inevitably volatile and you have a $1.575M loan. So, instead of quickly moving on to the 'next deal' makes more sense to operate your biz for at least a few years, learn, improve, pay down debt and grow SDE.
If you'd be happy w/ 5 businesses after 15 yrs, then you have 3 yrs/biz. This makes it a LOT easier, even w/out growth: operate for 3 yrs, pay down debt ($200k/yr plus $100k/yr of excess FCF), so your loan is down to ~1x SDE after 3 years + you have the cash equity for biz #2.
Plus, after 3 years, you understand the biz and can "manage remotely" more effectively. Take the $125k/year of owner comp you were paying yourself, use it to hire a quality operating partner, and start searching for biz #2.
One "trick" that might help early on: find a biz where the owner is passive (not operational) and there is a long-tenured GM that will stay (use some FCF and/or equity to incentivize). Then, you don't need to necessarily ding the FCF for the full $125k/year (from example above).
Plus, with the "passive seller + tenured GM" dynamic, your (buyer/new owner) efforts in the biz are 100% supplemental instead of necessary as the active owner replacement. And you have the GM's knowledge and know-how to keep the train on the tracks.

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More from @Sam_Rosati

5 Jan
Hardest thing about buying your first SMB? Deciding which biz in your pipeline is “good enough.” There are a million criteria checklists (e.g., HBS Guide) and rules of thumb. But nothing beats experience (and quality advisors/mentors) to help you make the really hard decisions…
Maybe it’s a pesky customer concentration issue, a biz with CapEx needs when you wanted something asset light, a price that’s a half turn too expensive, or a seller that wants to roll a little equity when you want to own 100%. When do you bend your own rules to get a deal done?
There is no perfect biz with a perfect price. Searching for perfection is part of what causes Search to take 2 yrs on avg– I made that mistake. It takes time & reps to know when to bend your rules, get a deal done and get into the driver’s seat (which is where the magic happens).
Read 4 tweets
21 Aug 20
Working on buying SMB w/ $1.5M EBITDA. As I work through financing, it’s pretty clear that the $1.5-2M of EBITDA range (give or take) is a sweet spot for SMB buyers b/c it’s an “in between” size for usual buyers. Too big for “job buyers” and too small for other folks (PE, SBIC).
For “job buyers” … after adding $250k deal expenses (SBA fee, lawyer, QofE, etc) and a $250k working capital cushion, the project cost is $6.5M. Subtract $650k seller note and $5M max SBA loan and the deal requires an $850k cash injection.
$850k is doable for some buyers, esp self-funded searchers w/ investors ready to write checks, but certainly not easy for “leave corporate world, buy a job” folks. Plus, SBA is super tight post COVID w/ max size loans ($5M) that have big airballs -> bigger cash injections needed.
Read 7 tweets

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