Selling to an Owner Operator

In a prior post, we indicated that there are three types of buyers and that each may evaluate a business differently or have restrictions on how they value and structure deals.  Here, we examine some of the intricacies of selling a business to an owner operator. 

While an owner operator may seem to indicate that a transaction is small, that is not necessarily the case.  Owner operators typically put down 10-25% on a transaction and get an SBA loan for the remaining portion of the deal.  Given that SBA loans range up to $5 million, the transactions can still be of reasonable size.   

The first thing to recognize about selling to this type of buyer is that the valuation metric they use will be different than strategic buyers or financial buyers.  Whereas strategic and financial buyers will most often use EBITDA as their valuation metric, owner operators will look at Seller’s Discretionary Earnings (SDE).  SDE adds back the owner’s salary to EBITDA so the owner operator has a higher cash flow, but they have to work full time in order to receive it. 

There are some big benefits to selling to owner operators.  First, the owner operator often doesn’t have the level of knowledge in your industry, so there is a lot of value in the intangible asset of your business.  That includes your systems, processes, built in customer base, etc.  A strategic buyer may not value your intangible as much as the owner operator since they already have their systems built, so it’s often the case for small businesses that an owner operator can pay more.  The lack of knowledge of the industry and oftentimes the lack of interest in allocating considerable resources to diligence will often lead to a simpler due diligence and one that keeps deals from being restructured after executing an initial agreement. 

The owner operator can often deal in smaller businesses or businesses with slow growth.  For example, a businesses with SDE of $150,000 may have EBITDA of 0 once the owner is replaced with a sufficient manager.  That could make it unattractive for a strategic buyer to do a deal, but still be worthwhile for an individual who historically made $100,000 in their prior job.  

However, there can also be drawback to selling to this cohort.  Given that owner operators are most often using an SBA loan, there are a few areas that deals get restricted.  The first is that the SBA does not allow earnouts.  So, in instances where a business is growing rapidly and the seller wants to get compensated for future growth, it becomes a challenge.  Buyers may be willing to pay for future growth on the come, but are rarely willing to do so upfront.  The SBA also does not allow any existing shareholder to stay on for longer than 12 months.  Buyers typically need the income that the seller had paid themselves so often don’t want the owner to stay either.  Where it becomes even a bigger problem is when a key employee is a shareholder and needs to work for the acquirer in order to maximize value. 

In summary, if an owner wants to continue working for an extended period of time, is hoping to participate in the future upside of their company, or has large cost savings opportunities when attached to a bigger business, an owner operator may not be the best type of buyer. 

However, should the business be small, have minimal infrastructure, the owner be looking to remove themselves from the business in a short period of time, or the owner be looking for simpler purchase agreement and diligence periods, an owner operator may be ideal.

Of course, each business in transaction is different, so it’s important for an owner to understand who the most likely buyer will be and operate in a way that not only maximizes value over time.  That means to consider not only the cash that is being received at the close of a transaction, but what the owner is making in the year’s leading up to the deal.