How 11% can cost you $100K at the closing table – Selling a Business
Business owners come to me and say, “I am thinking about selling my business, can you sell it?” I ask what price they want and I often hear 3x profits, 1x sales or similar.
I ask them what they think interest rates are on business loans. They reply, “I refinanced my loan in 2021 at 6%” or similar. I tell them good for you, today’s loan rates are about 11%.
Their jaws drop. Some realize their business value also just dropped, but many don’t see the connection.
Here is the math:
$1 million in revenues for your business
$100k (10%) net operating income (profits after all expenses before tax)
$80K owners salary
$200k Seller’s Discretionary Earnings (SDE).
The owner’ $200k is used to calculate the value of the business. Let’s say 3x or $600K selling price. Easy right?
Not so fast
The Buyer will pay 11% interest on a 10 year loan.
That $600K price after 10% down payment and 10% seller’s note
– $500K loan + working capital of $50k = $ 91K/year
– $50k seller’s note at 8% is another $7k/year
– Total debt is $98k/year total debt
Debt Service Coverage Ratio (DSCR) is NOI/loan payments, should be around 1.3
$100k/$91k = 1.09 DSCR – way too low. The Loan will not “cashflow”
The Seller must drop their price, or offer a seller’s note as “equity” for 10 years (the life of the loan), then get their money from the buyer.
In this case if the seller drops price by $100k, then the deal works. (I will spare you the math;)
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