I'm noticing a lot of posts from searchers with concerns regarding the economic environment. I wanted to provide some thoughts on this from my perspective as an investor and as a former searcher/operator.

First, it is not a given that the economy will enter a recession. Nobody can predict what will happen in the economy. Also, many of the best businesses were started/built during period of economic instability. You don't want to ignore the macro entirely, but you also can't let fear of what might happen prevent you from taking action and getting started. There are always period of economic uncertainty every few years. If you let these concerns paralyze you with fear, you will never be successful. Just keep your head down, focus on what you can control, and behave prudently. This is what all of the best entrepreneurs practice and preach. Personally, I purchased my business 4-months before COVID hit and then did a major (and highly accretive) add-on acquisition during the middle of COVID. Good opportunities have a way of presenting themselves during times of turmoil, but you have to be in a position and ready to capitalize on them when they happen. You can't do that if you're sitting on the sideline waiting for everything to look "hunky dory".

Second, the economic clouds on the horizon just reinforce the fact that what you're looking to do here is buy a good/great business, at a good/fair price, and finance it prudently. A truly good business, acquired at a fair price, and financed prudently should be able to survive nearly any economic scenario. You should always stress test your assumptions and projections. Does your deal implode if a worst-case economic scenario occurs or can you survive it? How much do sales have to decline before your cash flow turns negative? If your acquisition target and deal structure can't survive a 20% decline in sales, then you probably need to rethink your purchase price and/or deal structure.

What is a good business (at least for "search" or ETA)? A good business provides a necessary product or service, has non-economically sensitive demand, and/or has a high level of recurring revenue where the vast majority of customers are unlikely to terminate their buying if the economy is weak. For example, if you live in the south/north and your AC/heat goes out, you don't really have a choice but to have it fixed; if your house has water/fire damage, you have to get it fixed and usually your homeowners insurance company will pay to have it fixed; if your roof has a leak, you don't really have a choice but to have it fixed; etc. Ideally the business will have a high level of recurring revenue where 50-70% of the revenue is derived from monthly/quarterly/annual billings for some kind of product or service that is very important to your customers, has high value to your customers, and/or represents a relatively small portion of their budget.

Good businesses also generally have some kind of barrier to entry that limits the amount of new competition. Barriers to entry for small businesses are different than for Fortune 500 companies and can be geographical, high cost-of-living, local name recognition/reputation, scale related, etc. Barriers to entry are generally greater, and competition is generally weaker and less sophisticated, in small markets than in large markets/cities. If there are high barriers to entry for the business and/or market, most likely the business will have a high AND durable EBITDA margins (15% or greater). A good business for ETA should also have low customer concentration (e.g. no customer >5% of sales, top 10 < 20% of sales, etc.) so if you lose 1-3 big customers, whether due to the economy, or because they get nervous about a new owner, that the business isn't going to take a big hit as a result.

What is a good price to pay for a good small business? This depends on the size/quality of the business, but generally it is something like this from my experience: $250-$500k of SDE/EBITDA (2-3x SDE, 3-4x EBITDA), $500k-$1m of EBITDA (4-5x EBITDA), $1m+ EBITDA (5-6x EBITDA). If you buy a business at a good price, you will not need to use an excessive amount of leverage to be able generate attractive returns for you and your investors and thus will be less exposed to an economic downturn. More on this below, but given what has already happened with rising rates and banks getting more cautious, using a high amount of leverage is likely already off the table for you as an option anyway. This means you'll have to pay a multiple on the lower end of the range than what people have been paying over the past few years in order to generate an attractive financial outcome for you and your investors.

What is a good financing structure for the purchase of a small business? Again, in my opinion, it is best to be conservative here. You generally will want to have a debt service coverage ratio (DSCR) of >2.0x. That is, your EBITDA or discretionary cash flow, should be at least 2x your debt service obligations. The higher the ratio, the better you will be able to handle any economic headwinds and decline in EBITDA. If your DSCR is 1.5x or less, you are going to be in trouble if sales take a big hit, whether due to the economy or not. The way to have a high DSCR is to (1) not pay a high multiple, and (2) not use an excessive amount of leverage. Additionally, because much of the debt used to acquire small businesses is floating rate debt, you'll want to stress test your DSCR for higher than expected interest rates (ie. what happens if rates go to 8% or 10%?). Again, if higher than expected rates blow up your deal, it means you are either paying too high of a multiple and/or using too much leverage. Generally, deals should be structured with about 10-20% equity, 5-10% seller note, and 70-80% senior debt. However, given what has happened with rates, you'll likely want to decrease the amount of senior debt and increase the portion of equity and/or seller note to decrease the riskiness of the deal.

Another way to structure your deal smartly is to have a provision in your purchase agreement that allows you to offset against the value of the seller note if sales decline significantly and/or the seller makes a material misrepresentation to you (reps & warranties). You can do this with an SBA loan as long as the sales target isn't a "stretch goal". For example, if the business has historically done $3m in sales, you may want to have an offset right if sales decline by 10% or more versus the prior year period during the first 6 months of ownership. You'll get some pushback on this, but you need to align the seller's incentives with yours in terms of creating a smooth transition of ownership. Also, if the business requires a contractors license, you will want to have the seller qualify the business until you can obtain your license. This can and should be another requirement for the seller to get the full value of the seller note.

Finally, if you have a deal under LOI that you think meets the criteria I have laid out above, and are looking for an investor with experience acquiring, operating, performing add-on acquisitions, and strategically exiting a small business, feel free to reach out to me! I am actively looking to invest in searchers who are looking to go "all-in" on acquiring a high-quality non-economically sensitive business that they plan to own and operate as their sole professional endeavor during their period of ownership. Please send me a DM or email me at --@----.com