How much business can you afford? The math a lender will do

Most people start a business search with a price in mind. It's better to start with two numbers you already know: how much cash you could put in, and how much you need to pay yourself each year. Together they set a floor and a ceiling on the size of company you can buy, and they're the same two numbers a lender looks at first.

Here's how it works for an example buyer with $300,000 of cash who needs a $100,000 salary.

First, what "earnings" means here

When small businesses change hands, buyers and lenders look at owner earnings: the company's profit plus what the current owner pays themselves, before loan payments and taxes. It answers a simple question: if you owned and ran the company, how much money would it leave each year for you and your lender to share?

Second & Main's estimates put most established small companies at around 2.5 to 3.5 times a year of owner earnings. Where a company lands depends on its industry, its size and how much it relies on the owner. We'll use 3 times below.

The ceiling: what your cash can cover

Most small business purchases are financed with an SBA loan, a bank loan partly guaranteed by the U.S. Small Business Administration. When you buy a whole business, you usually have to put in at least 10% of the price. Add roughly 4% for closing costs, and your cash needs to cover about 14% of the price.

So $300,000 of cash supports a price of up to about $2.1 million ($300,000 ÷ 0.14). At 3 times earnings, that's a company earning about $714,000 a year.

That's as far as your cash can stretch. It isn't a target: a company at the very top of your range leaves you with nothing in reserve.

The floor: what the business has to earn

This is the part people skip, and it's the part lenders care about most. The business has to pay you, pay the loan, and still have room to spare.

Lenders measure that room with a ratio. After your salary, what's left should be at least 1.25 times the yearly loan payment, so a bad year doesn't sink you.

An SBA loan to buy a business is typically paid back over 10 years. At an interest rate of about 10.25%, every dollar you borrow costs about 16 cents a year. Here's how that works out for our example:

• At 3 times earnings, a company earning $218,000 costs about $654,000.
• You'd borrow about 90% of that, roughly $589,000, which costs about $94,000 a year to repay.
• After your $100,000 salary, the company has $118,000 left, which is 1.25 times the loan payment.

Below that, the numbers stop working. So with a $100,000 salary, you're looking for companies earning at least $218,000 a year.

Your range

With $300,000 and a $100,000 salary, you can afford a company earning roughly $218,000 to $714,000 a year, at a price of about $650,000 to $2.1 million.

A few things move the range:

• The salary you need. A higher salary raises the floor. Needing $150,000 instead of $100,000 pushes the minimum up by about $109,000 of earnings.
• Your cash. It moves the ceiling, not the floor. More cash lets you buy bigger, but it doesn't make a small company work.
• Interest rates. Higher rates raise the floor.
• Seller financing. If the owner agrees to be paid part of the price over time, you need less cash and less bank debt.
• The industry's price. If companies in your industry sell for 2.5 times earnings instead of 3, your cash buys more earnings.

When the numbers don't meet

Sometimes the floor is above the ceiling: the salary you need calls for a bigger company than your cash can buy. You have three ways to close the gap: bring more cash or a partner, take a lower salary for the first few years, or find a seller willing to finance part of the price.

What this doesn't tell you

This is the arithmetic a lender starts with, not a loan approval. A lender will also look at your experience, your credit, the company's tax returns and how much of the business depends on the current owner. Use the range to focus your search, and talk to a lender and an accountant before you make an offer.

When you run a search on Second & Main, we do this math for your cash and your salary, using each industry's typical price, and show you which established companies fall inside your range.