My client was buying a business using a part-time search. He found a deal that felt right, but the business was represented by an investment bank. That’s not typical for deals with $500,000 in Seller’s Discretionary Earnings (SDE). Usually, a business broker will represent businesses of this size. That raised my eyebrows a bit when we received the initial packet of information.
The first thing that stood out was a line on the income statement: “Other income” accounting for $120,000. No other explanation. Then, I found loans on the balance sheet that weren’t designated in any particular way. Neither of these items is typical. My immediate assumption was that the business was trying to pass off a Paycheck Protection Program (PPP) loan during the pandemic as regular income in order to boost SDE.
When PPP loans were provided to countless businesses to stabilize the economy during the pandemic, they were meant to be a one-time occurrence. That means they should not be considered part of any recurring revenue or profit that the business will earn. However, many owners and brokers have been trying to pass PPP loans off as revenue which means that number is included as part of SDE.
I asked again and again about this issue, but I couldn’t get a straight answer about the PPP loan. My client even got frustrated with me because he felt that I was asking the same question too many times. Since no answers were being provided, I knew there was something behind these line items. Let’s just say my spidey sense was tingling!
After 7 or 8 times asking the question, the investment banker finally hopped on the phone and revealed that there were two PPP loans. One had been forgiven. The other had not yet been forgiven, but they expected it to be forgiven. Exactly what I thought. My game of Where’s Waldo was worth it.
That outstanding unforgiven loan created a $120,000 liability that my client might eventually be responsible for paying if he had not caught it. We adjusted the SDE down $120,000 to remove the PPP loan that should have never been included as a part of SDE in the first place. That adjustment saved my client $480,000 on his purchase price (4x on the $120,000).
We would have never gotten this outcome if I hadn’t been persistent. If we didn’t spend the time to ask the questions and push the investment banker for answers, we never would have recognized that additional liability or adjusted the SDE appropriately. I’m glad I had my practice finding Waldo back in the day!
What other questions should you ask?
I compiled a list of the most important questions that guide the due diligence process for first-time buyers and self-funded searchers. Download to find out what you need to know about your deal.