The year-1 return on an illustrative 1,500,000 SBA-financed purchase, measured after paying the owner a market salary.
The return on buying a small business is the cash left after paying yourself a market salary, tax, capital expenditure and the loan, divided by the cash you put in. On an illustrative 1,500,000 purchase financed with a 10 per cent injection, year-1 cash-on-cash is 80.7 per cent: 133,107 on 165,000. The figure buyers usually quote, SDE less debt service over the injection, is 202.7 per cent, and it counts your own wage as investment return.
Worked in full in Buying a Small Business by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A buyer acquires a service business with 570,000 of verified seller's discretionary earnings (SDE) for 1,500,000, or 2.63 times SDE. The project also funds 60,000 of closing costs and 90,000 of working capital, so the total is 1,650,000. The buyer injects 10 per cent and the rest is a 10-year amortising loan at an illustrative 10.0 per cent. A manager to run the business would cost 120,000 a year. All figures are illustrative; tax is simplified to a flat 25 per cent with the whole price amortised over 15 years.
| Item | Value |
|---|---|
| SDE, verified | 570,000 |
| Market salary for the owner's role | 120,000 |
| Purchase price | 1,500,000 |
| Closing costs and working capital | 150,000 |
| Total project cost | 1,650,000 |
| Buyer's injection (10%) | 165,000 |
| Loan, 10 years at 10.0% | 1,485,000 |
| Maintenance capital expenditure | 30,000 |
SDE adds back the owner's entire compensation. That is right for comparing businesses but wrong for measuring a return, because the buyer who works in the business is earning a wage for the work. Deduct what the job would cost if someone else did it: 570,000 − 120,000 = 450,000 of EBITDA. The price is then 3.33 times EBITDA. The full bridge, with rejected add-backs, is in how to convert SDE to EBITDA.
Monthly payment = 1,485,000 × r / (1 − (1 + r)−120), r = 10.0% / 12 = 19,624
Excel: =PMT(10%/12, 120, -1485000); annual debt service 235,493
Year-1 interest 144,400; principal 91,093
Taxable income = 450,000 − 144,400 − 100,000 amortisation = 205,600; tax 51,400
| Line | Amount |
|---|---|
| SDE | 570,000 |
| Less market salary | -120,000 |
| EBITDA | 450,000 |
| Less capital expenditure | -30,000 |
| Less tax | -51,400 |
| Less debt service | -235,493 |
| Free cash to the owner | 133,107 |
| Cash-on-cash return on 165,000 | 80.7% |
On top of that, 91,093 of principal is repaid in year 1. Counting it gives a return on equity of 135.9 per cent, but principal only turns into cash at a sale or refinancing, so it belongs on a separate line. Before any debt, the business yields 332,500 after tax and capital expenditure on a 1,650,000 project: 20.2 per cent unlevered. Everything above that is leverage, and leverage cuts both ways.
| Price | Injection | Salary 80,000 | Salary 120,000 | Salary 160,000 |
|---|---|---|---|---|
| 1,300,000 | 145,000 | 126.9% | 106.2% | 85.5% |
| 1,500,000 | 165,000 | 98.9% | 80.7% | 62.5% |
| 1,700,000 | 185,000 | 76.9% | 60.7% | 44.5% |
A 40,000 change in the salary assumption moves the answer almost as much as 200,000 of price does. A buyer who plans to hire a general manager should use the real quote, not a figure chosen to make the return look healthy. A larger injection lowers the percentage but makes the deal safer: at 20 per cent equity, 330,000, cash-on-cash falls to 47.0 per cent while cash coverage of debt service rises from 1.57 to 1.74 times.
Stress the result. If SDE falls 20 per cent to 456,000 with the salary unchanged, EBITDA falls 25.3 per cent to 336,000 and free cash falls 64.2 per cent to 47,607, a cash-on-cash return of 28.9 per cent. Fixed debt service is why a modest drop in earnings becomes a large drop in the owner's cash.
The listing says the business "makes 570,000 a year" and costs 1,500,000, so the buyer reads a 38.0 per cent return, or, with the loan, 570,000 less 235,493 of debt service on a 165,000 injection: 334,507 and 202.7 per cent. Both numbers include the owner's salary, before tax and before any capital spending. The buyer who quits a 120,000 job to run the business has not earned 202.7 per cent on 165,000; they have earned their old salary back plus 133,107. Comparing that 133,107 with the 165,000 at risk, and with what the same money would earn elsewhere, is the honest version of the decision.
The free workbook for this case runs the book's own acquisition through ten years with both the lender's coverage and the cash coverage after capital expenditure and tax, which is where the gap between what the bank approves and what the owner keeps first shows up.
There is no single figure, because the return depends mostly on leverage. With a 10 per cent injection, cash-on-cash returns well above the unlevered yield are normal: 80.7 per cent here against 20.2 per cent unlevered. The test is whether the return survives a bad year: a 20 per cent fall in SDE leaves 28.9 per cent, still positive, and coverage still above one.
Yes. SDE includes the owner's pay, so a return computed on SDE mixes a wage for working in the business with a return on the money invested in it. Deduct a market salary for the role first: here 120,000, which turns 570,000 of SDE into 450,000 of EBITDA. Every 40,000 of salary assumption moves year-1 cash-on-cash by about 18 points.
It builds equity but it is not cash in hand, so report it separately. Here year-1 principal is 91,093; adding it to the 133,107 of free cash gives a return on equity of 135.9 per cent. That value only becomes cash at a sale or refinancing, and only if the business is still worth what was paid.
This article is one calculation from Buying a Small Business. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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