Your banker knows why 3 is a magic number for a small business seller.
When a bank lends money for a business acquisition, understandably the bank looks at the financial results of the business being purchased. The bank wants to know that the business will generate financial results sufficient to pay off the loan incurred to buy the business.
But what many small business sellers don’t know is that the bank doesn’t just look at the last year of income. The bank averages the results of the last three years together to come up with the number they use for income from the business.
Seller’s are often surprised to learn that their buyer can’t get a loan for their business because the three-year average of results pushes the desired purchase price out of reach.
And if the bank won’t borrow, the buyer usually can’t buy.
“But finding the money to buy my business is the buyer’s problem,” screams the voice in the seller’s head.
Yes, that’s true, but it's the seller's problem as well. You as the seller can make the “find the cash” problem insurmountable for your potential buyer. If you want to dramatically increase your odds of selling, your financial results need to support the repayment of the loan your buyer is pursuing.
It's one of two basic needs that your buyer has, and if your business can't meet these needs, you are unlikely to sell your business.
Articles about getting a loan to buy a business don’t necessarily highlight the three-year average, which is one of the reasons why the requirement can be a surprise. But they do make the need for the information clear:
“We will ask you to provide us with . . . copies of your business federal tax returns for the last three fiscal years." CapitalSource.com
A lender will ask for records of the company’s recent tax filings, balance sheets and P&L statements, among other documentation. - via Forbes: Four Prerequisites Before Applying for a Business Acquisition Loan
Lenders are typically more inclined to lend money to someone buying an existing business rather than someone launching their own startup. This is because the existing business has a financial track record, which makes assessing the likelihood the business will be able to repay the loan much easier.
Lenders prefer the business to have been operating for 2-5 years and will want financials to show that the business is profitable, and your revenues are stable or growing. - FitSmallBusiness.com: How to Get a Loan to Buy a Business in 2018
The three-year average also means that your current efforts to increase your SDE, while important, can take a few years to make a substantial impact. If previous years SDE are substantially lower, they will drag down your average and lower the funds a bank will loan.
Being prepared for the "three year average" expectation can magically raise your odds selling your small business for the value you want. But being unprepared for the three year rule will make your chance for a sale disappear.