Twice each week, I break down real businesses for sale on the Acquisitions Anonymous podcast. What better way to learn about business than by studying real businesses each week?

My favorite part about the podcast is the meta-lessons we learn that are more broadly applicable than just the business we are analyzing. That's what today's newsletter is about.

Recently, my co-host Heather Endressen and I broke down a $2M EBITDA ecommerce business — I'm featuring it here not just because I love this stuff (I really do), but because there’s some valuable takeaways in this specific episode worth expanding on.

The business listed for sale:

• 9 years in business, Amazon FBA
• Niche: snack boxes and gift baskets
• $13.3 million in revenue
• $2.2 million in seller’s discretionary earnings
• Revenue split: Amazon 95%, Shopify 4%, Walmart 1%
• Category best seller, brand leader, 77k reviews across 87 SKUs
• Company and logistics operate out of a fully equipped 58k square foot warehouse
• 25 full-time employees
• Asking Multiple: 2.75x

Asking price: $6.2M + Inventory

On the face, this business is attractively priced. But, as my co-host Heather pointed out, SBA loans max out at $5 million, and this business is asking $6.2 million… plus inventory. Anyone buying this business will have to bring quite a bit of equity on top of a $5M SBA loan.

This is one of the biggest inefficiencies in today’s M&A market. If SBA maxes at $5 million, and most small businesses trade at 3-4X EBITDA, that means the largest business you can buy with an SBA loan is roughly $1.5 million or so. At the same time, private equity firms really don't get interested until a business in the $3-5 million range of EBITDA. So there's a real gap between ~$1.5M and $3M in EBITDA - there isn't really a lot of debt available to finance these transactions.

A business this size is in no man’s land. Small business acquirers can’t buy it because they can’t get enough debt (since SBA maxes out at $5M), and it’s too small for private equity.

Takeaway #1 - You have to buy inventory too:

It's important to note that this listing is priced plus inventory — which has always been one of my pet peeves. Here are few of the questions I normally ask with deals like this:

Q: Can I buy the business without the inventory?

A: No, of course not.

Q: So the inventory is required for the business to run?

A: Yes!

Q: So why isn't it included in the purchase price?

A: *crickets*

This is usually done to protect the sellers who may have "too much inventory" (which is subjective) at closing. But it’s not the buyer’s responsibility to bail out the seller for their poor inventory ordering decisions — especially if the inventory will become outdated, or in this case, expired.

Only pay for inventory you can guarantee you’ll sell. If there are slow moving products, structure the deal where you pay nothing for all items with more than two years of inventory.

You also need to account for the true purchase price of the business including inventory — if the inventory for this business is $1.5 million, the true purchase price just went up from $6.1 to $7.6 million. That’s a ~3.5x multiple, much higher than the 2.75x multiple they’re listing.

Takeaway #2 - SDE is not EBITDA:

This business is doing $2.25 million in EBITDA, and the owner works in it day-to-day. If you don't want to be the hands on CEO, you're going to hire someone to do that job, and their salary is not in the P&L right now. A good CEO will easily cost you $250k/yr. So you have to mentally adjust this business's EBITDA down to $2 million. That’s the real EBITDA if you don’t work in the business.

Combine that with the added purchase price for inventory, and this is really a $2M EBITDA business for sale for $7.6M - a 3.8x multiple, which is a full turn higher than the 2.75x claimed in the listing.

So pay attention when businesses are priced as a multiple of seller's discretionary earnings (SDE). When you have an SDE multiple, the effective multiple is actually higher if you don’t want to work as the full-time CEO.

Let’s show a more extreme example: If a business has $500K of SDE, and you have to hire a $250K CEO, your multiple just doubled. Your 3x multiple is actually a 6x multiple when you burden with the CEO’s salary.

Bottom Line:

Account for inventory and the seller’s take-home when looking at the multiple. The whole point of a multiple is how much cash flow comes out from the cash you put in — but here, there's less cash flow than you think because of the SDE/EBITDA difference with the seller’s salary, and there's also more purchase price than you think because inventory is not included.

Ultimately, Heather and I decided we wouldn’t buy this business because of how tough it would be to finance. Also, I’m not really a gift basket guy. If you want to watch the full episode, it's on YouTube, Apple Podcasts, and Spotify.

If you liked this newsletter, I have 4 places where I share more like it:

1. 👔 The 1-1 coaching that I do with CEOs (I currently have ONE slot open).
2. 🐦 I tweet (a lot) - follow me @BillDA.
3. 🎙️ My podcast, Acquisitions Anonymous, where we break down real businesses that are for sale.
4. 📬 This weekly newsletter! Click here to subscribe and read past issues.

Until next time,
Bill D'Alessandro