Buying a Small Business for Less than $1 Million: 5 Key Pillars

I have talked a lot about why I think there is an opportunity to buy small businesses.  If you haven’t already, you might want to read through these posts to set the stage:

1. The Silver Tsunami of Small Businesses for Sale is Here
2. What Makes a Small Business Unsellable? 
3. The SMBuyer Way to Buy a Small Business
4. What Kind of SMB am I Looking to Buy?

The high level idea is that there are going to be millions of small businesses for sale over the next 5 to 10 years as baby boomers retire.  Roughly 90% of those businesses will be valued at less than $1 million.  The “standard” way to buy a small business that you will read about online and from industry experts doesn’t work as well for small businesses valued at less than $1 million.  The reason it doesn’t work is primarily because of the fees associated with the typical transaction, and the smaller the transaction is, the less likely it is to work. 

So I have put together what I am calling “The SMBuyer Way” to buy a small business which has 5 key pillars that I think will ultimately reduce the fees and headaches associated with buying a business.  I think these key pillars will unlock the ability to buy many smaller businesses that would otherwise just close up shop.

Before I dive into the pillars, let me just give a quick primer on the problem with fees. 

Fees to Sell a Small Business

I created this little calculator to show how the fees, taxes and seller financing associated with a typical small business sale can eat up over 50% of the sale price in a small transaction.  

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I estimate the fees alone for the buyer and seller could reach $170,000 for a typical $1 million business sale.  I think it is possible to reduce those fees to $20,000 when using “The SMBuyer Way.”

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It seems to me that by reducing the by $150,000 the buyer has a chance to win the deal and beat out other offers because they can offer $150,000 more toward the purchase price / the seller will get $150k more in their pocket on day 1.  

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Additionally, I think sellers don’t realize how little cash they are actually going to receive on day 1 after selling their business, and when they do realize, they may decide selling isn’t worth it.  Reducing fees as much as possible can help get the seller to agree to sell.  

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This is a great thread on a larger deal that blew up at the closing table when the seller realized they would only receive $3 million on their $5 million business sale.  

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So let’s dive into the 5 pillars. 

5 Pillars of Buying a Small Business

Pillar #1 - Find Off Market Deals

The traditional way to buy a small business is to work with a business broker (like a real estate agent who helps you find a business to buy) or look at sites like BizBuySell where seller’s list their business for sale.  

Although this is a convenient way to find businesses that are available for sale, there is a cost.  A business broker will likely take a 10% commission of the sales price of the business for a business valued at $1 million or less.  

As the buyer you can kind of get tricked into the idea that you aren’t paying that 10% because it comes out of the purchase price, so the seller will just receive 10% less.  

But if you think about it, the seller isn’t surprised by this fee, so if the seller wanted to sell for $1 million and decided to use a business broker, I think the first step would be to raise the price to $1.1 million to cover the broker’s fees.  So ultimately the buyer is paying a higher price than they might need to otherwise.  

Many small businesses will still be sold through business brokers, but I think the opportunity for you as an SMB buyer is to find off market deals.  So how do you find a small business that is open to selling, but is not listed for sale.  I plan to dive into ideas on how to find off market small businesses to buy later, but here are some initial ideas:

1. Networking:  Engage with business owners in the industry or location you are interested in buying a business.  Join industry specific associations, chambers of commerce, or business clubs.   
2. Social Media:  By producing content on Twitter, Youtube, and LinkedIn you can actually act as a magnet to attract small business owners that might ultimately want to sell to you.  Writing and sharing your ideas online is a wonderful way for people to get to know you and build some initial trust. 
3. Direct Outreach:  You can use publicly available data to identify potential small businesses that might meet your criteria and reach out to them directly.  

These are a few ways to find an initial lead, but you will need to run this like a sales process and nurture those leads.  Build relationships with the owners as best you can so that when they are ready to sell, they will think of you. 

Yes there will be some work involved with finding off market deals, but I suspect the 10% savings is going to unlock some opportunities for you that would not otherwise exist. 

Pillar #2 - Skip the Formal Valuation

A formal business valuation or appraisal can come with significant cost.  At the end of the day the sales price is a negotiation between the buyer and the seller.  So I think for small transactions you can probably skip the formal valuation.  You can find plenty of free, publicly available data that will help you estimate the valuation of the business.  

BizBuySell publishes the average revenue multiple and the average cash flow or earnings multiple for businesses sold on their platform which can give you a great starting point for negotiations.  

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You can also find industry specific multiples on BizBuySell.  You can see a sample of that data below: 

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With this data in hand I think you can find a good, data driven ballpark for valuation, then depending on specific details like growth rates, customer concentration, projections, etc you might be able to justify a higher or lower valuation.  

I think this is a good way to avoid $10,000 in fees and the additional time and headaches associated with completing a valuation.  

Pillar #3 - Finance with a Seller Note

Selling financing means that you will pay the seller over a period of time, often from the profits of the business.  The key downside is that the seller will not get the full purchase price paid up front in cash.  The best SMBs for sale will likely be able to demand being paid up front.  This is the common approach when using an SBA loan, but when you introduce an SBA loan you also introduce a lot of extra complexity and time to close the deal.  

The SBA and bank lender will have their own fees, they may require appraisals which will come with additional fees, they will increase legal fees because of the additional requirements and agreements needed, and it will likely increase your time to close by at least 60 to 90 days.  So if the seller is in a hurry to close the deal, avoiding the SBA can be a nice benefit.  

As a buyer you might be able to agree to a higher sales price if the seller is willing to finance the deal.  I also think most sellers are going to want a chunk of cash at closing no matter what, so as a buyer you should be prepared to save cash or take out a personal loan, HELOC, or find some other source of cash to provide a chunk of cash at closing. 

If you can do that, then I think a seller might at least be willing to listen to a seller financing proposal.  If you are going to pay the SBA 8% on an SBA loan, you could pay at least that 8% interest to the seller on the seller note which means the seller will ultimately earn even more on the sale, it will just take more time.  

Another thing to consider is that a buyer might not be able to qualify for an SBA loan for the business which means that a seller night might be the only/best option.  Once the buyer has owned the business for a year or two banks are more likely to be willing to lend to the business / new owner based on the performance of the first year or two.  At that point, the buyer might be able to refinance the seller note with a bank loan and get the buyer paid in full.  

Seller financing can certainly save on fees and allow a transaction to close faster.  If you have a good, trusting relationship with the seller, they are much more likely to be willing to offer seller financing.  

Pillar #4 - Retain the Seller as a Consultant

Another lever that I think you can pull to get a deal done is to retain the seller as a consultant. Let’s say the seller wants $500,000 for the business, but you only want to pay $400,000 for the business.  A good way to bridge that gap is to retain the seller as a consultant and if the business meets certain requirements / the seller helps in the transition, you could pay the seller the additional $100,000 over time as a consultant.  

You may have also heard about earn out agreements which is a way to set aside some portion of the sale price and require the seller meet certain requirements in order to earn the rest of the sales price.  My understanding is that this complicates things quite a bit from a legal perspective.  You will end up spending a lot more in legal fees to set up and to monitor an earn out agreement vs. a simple consulting agreement.  

Pillar #5 - No Investors

Finally, for most small businesses valued at less than $1 million I don’t think it is worth it for the buyer to bring on investors in the deal.  There are several reasons for this:

1. Bringing on an investor will complicate the process and increase legal fees in the transaction. 
2. There will be ongoing costs associated with having an investor.  It will complicate your taxes every year and add cost.  
3. There probably is not enough upside for the investor to compensate for the additional costs, headache and downside risks.  

For example, let’s say you raise $100,000 from an investor for a $500,000 business acquisition.  You might have an extra $10,000 in initial legal fees, $10,000 in initial CPA fees and then at least a few thousand dollars worth of extra tax accountant fees each year.  When you run the numbers, it is going to be difficult to make that investment make a whole lot of sense for the potential upside in most SMB acquisitions.  Having an investor limits your options, complicates things, and adds costs.  I would look for a way to make a deal work without an investor. 

So with these 5 pillars in mind, I think you can unlock opportunities to buy a small business that simply might not be possible if you were following the “traditional way.”

I would love your feedback.  What are some other ways to simplify the business buying process?