The SMB lingo is hard to grasp, even for the most experienced buyers. Rather than googling every term and getting a vague answer, we thought we would make you an all-in-one glossary of terms you will need to know as a first-time business buyer!
MPSP - Most Probable Selling Price
Taken from page five of this document, it is the value that the DealBuilder system has determined as the price that a purchaser is likely to pay for this business.
SDE - Seller’s Discretionary Earnings
SDE is a calculation of the total financial benefit that a single full-time owner-operator would derive from a business on an annual basis. It includes all salaries or wages paid to the owner (just one) along with any “discretionary” expenses that are paid for by the company that benefits that single owner directly but are not necessary for operations.
New Owner’s Salary
The amount of money the new owner of the business needs to make to pay their living expenses. It is expressed as a gross amount, not a take-home amount.
Loan – Financial Institution
Based on the experience of DealBuilder, this is the amount of money, in what is known as a cash flow loan, with expected terms, that a financial institution might lend to a qualified person wishing to purchase this business.
Loan – Vendor Financing
The amount and terms of a loan that the seller might be willing to the purchaser to facilitate a deal. This is a common practice and creates a lot of confidence for both the buyer and the banker in the quality of the proposed transaction.
Cash Flow Loan
This is a type of loan that is not supported by assets in the form of collateral. The criteria for approval are the creditworthiness of a business purchaser and the historical ability of the business being purchased to provide adequate “cash flow” or profitability from which to pay back the loan. A buyer should expect to have to make personal guarantees on such a loan but his house and other assets would remain unencumbered.
Closing Costs
A buyer will need to pay for professionals such as accountants and lawyers to assist in the closing of a transaction. DealBuilder uses its experience to suggest an amount to the budget. This amount is included in the return on invested capital calculations.
Cash Flow Allowed by Banks
A banker will accept only the adding back of interest, amortization, depreciation, income tax and owner’s salary to the net profit shown on the accountant-prepared income statement. What this means is that any other adjustments made like auto expenses, insurance, cell phones, non-essential employees, bad debt, one-time expenses, etc, will not be recognized when the bank is analyzing a deal in which they have been asked to lend money. For example, if your SDE is $150,000 but $30,000 was added back for your personal vehicle expenses, the bank will do its calculations based on $120,000.
Estimated Corporate Tax
This number represents the amount of corporate income tax a business will need to pay. The amount is included in the return on invested capital calculations. It requires knowledge of what the corporate tax structure is for the business’s state or province.
Total Annual Debt Servicing Costs
The total amount of money paid each year to service the interest and principal of money borrowed to purchase the business from a financial institution and/or the seller of the business.
Minimum Buyer Equity Required
This is the least amount of unencumbered cash a buyer would require to purchase this business based on the general lending policies of lending institutions. This does not mean that a lending institution will make a loan based on this amount of down payment but only that it is possible with favourable conditions as deemed by the bank.
Financial Institution Monthly Payments
The monthly amount of money required to be paid to the financial institution by the purchaser is based on the amount of the land and the terms – interest rate and length of the loan.
Vendor Financing Monthly Payments
The monthly amount of money required to be paid to the seller of the business by the purchaser is based on the amount of the land and the terms – interest rate and length of the loan.
Discretionary Income Not Allowed by Banks
See Cash Flow Allowed by Banks. This is the dollar amount of the adjustments that were removed by a financial institution to determine the amount of cash flow available that a banker would consider in assessing the debt servicing capability of the business.
Debt Servicing Covering Ratio
The Debt Servicing Covering Ratio (DSCR) is a measurement of a firm's available cash flow to pay current debt obligations. The number represented here is the minimum required by the bank for them to consider making a loan.
EBITDA - Earnings before Interest, Taxes, Depreciation, and Amortization.
EBITDA is an indicator of a company’s financial performance. In this application it is calculated as follows: SDE – Owner’s Salary. In essence, it is the Net profit of the business plus interest on long-term debt plus taxes plus depreciation and amortization.
Minimum EBITDA Required
This is the minimum amount of EBITDA in dollars required to comply with the demands of the DSCR required by the bank. For example, if the DSCR is 1.25 and the total annual debt serving is $50,000, the minimum EBITDA required is $62,500.
Estimated Bankable EBITDA
See Cash Flow Allowed by banks, this amount is what a bank will be willing to consider when assessing the viability of a loan for an anticipated transaction.
Estimated Taxable Corporate Profit
In this application, the number is calculated by taking the SDE – the owner’s salary, minus the estimated interest on the loans.
Implied EBITDA Multiple
This is an expression of the MPSP as a factor of the EBITDA. The number is calculated by dividing the EBITDA by the MPSP. It gives a quick ratio of earnings against the MPSP giving a sense of how long it would take to regain the MPSP and therefore implied purchase price of a business. A business with an EBITDA of $200,000 and an MPSP of $800,000 would have an implied multiple of EBITDA of 4. In theory, the purchase price is recovered in 4 years.
Implied SDE Multiple
This is an expression of the MPSP as a factor of the SDE. The number is calculated by dividing the SDE by the MPSP. It gives a quick ratio of earnings against the SDE and is useful in quickly comparing this business to other business buying opportunities.
Owner Equity
The amount of money the buyer has contributed to the purchase of the business. This includes the cash they are contributing to the purchase price and the closing costs.
Retained Earnings
Retained earnings are calculated as follows: SDE – Owner’s Salary – Annual Debt Servicing – Tax = Retained Earnings. It is used in calculating the cash-on-cash return on the owner’s equity.
ROIC – Return on Invested Capital
The invested capital refers to the buyer's personal money used to make the purchase (see owner’s equity). ROIC is a calculation used to see how much money is made annually on the owner’s equity
ROIC – Return on Invested Capital – Cash on Cash
This is the percentage return on the owner’s equity based on the cash left over after debt servicing the owner’s equity and cash. This is what Dealbuilder refers to as "Retained Earnings".
ROIC – Return on Invested Capital – Including Repayment of Principle
This is the percentage return on the owner’s equity based on Retained Earnings plus the repayment of the principal. Although the repayment of principal is not cash available to the new owner, it is an increase in the equity position of the company. If the purchase price of the business was $500,000 and the buyer borrowed $250,000 to purchase the business to be repaid over 5 years, then the buyer’s equity and by implication their personal net worth increases by $50,000 per year on average. Should they sell the business for the same amount after the five years, the $250,000 of cash they had when they purchased the business is not $500,000 of cash. This is of course in addition to all of the owner’s salary and retained earnings they enjoyed along the way.
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