Great thread, to summarize:
It's really important to involve your bank before negotiating a business purchase. Eager buyers jump into deals without checking with lenders and find out later that the price isn’t eligible for financing. Banks rely on lots of metrics like Seller’s Discretionary Earnings (SDE) and price-to-earnings (P/E) multiples to assess valuation.
From my experience, business earnings get padded with lots of one-time adjustments, personal expenses, or other questionable add-backs that don’t hold up under due diligence. When the deal is closed and the numbers don’t add up, it’s a hella expensive lesson.
If you’re considering buying a business, here’s how to break down the financials:
Seller’s Discretionary Earnings (SDE)
SDE is foundation for valuing small businesses. It starts with net profit and adjusts for expenses that are discretionary or one time. The formula is:
SDE = Net Profit + Owner's Salary + Discretionary Expenses + Non-Recurring Expenses - Non-Cash Expenses
Example: if the business shows $50,000 in net profit, $40,000 in owner’s salary, and $10,000 in non-recurring legal fees, the SDE would be $100,000.
Price-to-Earnings (P/E) Multiple
The asking price is normally expressed as a multiple of SDE. The formula is:
P/E Multiple = Asking Price / Adjusted Earnings (SDE)
Example: if a business priced at $600,000 generates $150,000 in SDE, the multiple is 4X ($600,000 ÷ $150,000). Banks likely won’t finance deals over 5X, and anything above 3X should come with strong justification or additional concessions, like vendor financing.
Debt Service Coverage Ratio (DSCR)
Banks use DSCR to assess whether the business can support its debt payments. The formula is:
DSCR = Net Operating Income (NOI) / Total Debt Payments
For example, if the business’s NOI is $200,000 and annual debt payments are $100,000, the DSCR is 2.0. Most banks look for a DSCR above 1.25, and 2.0 is ideal.
Loan-to-Value Ratio (LTV)
LTV measures how much of the purchase price is covered by the loan. The formula is:
LTV = Loan Amount / Business Value
Example: if the loan is $700,000 and the business value is $1,000,000, the LTV is 70%. Banks typically prefer LTV ratios below 70-80%.
If you’re buying a business, the process needs to start a the financial level. Request detailed financial statements and calculate the core metrics, and verify any adjustments made by the seller. Involving BDC or other banks early can flag unrealistic multiples and provide a reality check on financing options. When negotiating, if the seller is asking for a high multiple, push for vendor financing or an earnout (sale price paid over # of years, or based on revenue / profit) to reduce your risk.
There is going to be a ton of business acqusition opportunities in 2025, but great deals are always hard to come by.