Many people ask how much cash flow they need from their acquisition target. When an individual buys a business, the answer is: at least enough to afford you a good living. This may be $75,000 to $100,000 per year. While this may sound low, it is only a minimum and is subject to dramatic increases when acquisition debt is paid off and/or the business is grown. Moreover, the business will often have management in place so that your time is freed up to increase cash flow in other areas.
When analyzing the acquisition candidates it is important to know what sort of business is too small to buy. I’ll give you examples. I go into a pizza place every week and buy their great pizza. The owner is there all the time barking orders to 6-8 workers. It’s a popular place with a local following so he could be making $300,000 a year net and he doesn’t even take credit cards.. But the owner is chained to the hot kitchen 6-7 days a week. And the business won’t get any bigger, at least with that one location. OK, let’s assume we don’t want to spend our days in a pizza kitchen barking orders. Where do we go from here?
We need to go a level up. $400,000 to $500,000 of net cash flow per year starts to get us interested. Why? Because that sized business is generally larger than the average retail establishment and requires a level of management to support it. The level of management is key. We need the business we buy to be self managed because we are not going to show up there every day, at least that is the assumption we make. Sure, once the business is bought we can show up anytime we want – but we always want the option to not show up. Thus we need that earnings level to be high enough to support that kind of layer of management and still afford us that minimum level of salary.
What will we do with that earnings level. Well, if we get $400,000 of earnings from the new company and we have $300,000 of debt service, well that leaves $100,000 for our brand new salary. So all we need to do is structure the deal so that the debt service is no more than $300,000. Right? Well, almost. That is cutting it pretty close. There are many nuances to tuning up the right structure. But yes, that is it in a nutshell.
