A common area of confusion among advisors is understanding the difference between a “Main Street” business, a “Middle Market” business and a “Mom and Pop” business.
Main Street Businesses
The term “Main Street” is defined by the International Business Brokers’ Association and other professional intermediary organizations as any company with a Fair Market Value of less than $3,000,000. That is about the upper limit of a business that can be purchased by an individual using “normal” 20% down financing. They are making the acquisition for the purpose of earning a living.
Main Street businesses typically calculate cash flow as Seller’s Discretionary Earnings (SDE). As discussed by Scott Gabehart, the creator of BizEquity valuation software, SDE is a better measure of a business’s return on owner labor, rather than return on investment. SDE includes the benefits of ownership including salary, employer taxes, distributions, health insurance, vehicle and other perks of ownership. It also includes non-cash tax deductions such as depreciation.
The average selling price for an owner-operated business in the United States is 2.3 times its SDE. That cash flow must support any debt as well as provide a living for the principal operator.
If we extrapolate from the average multiple (which is accurate based on my past experience as a business broker), we would say that “Main Street” encompasses businesses that produce up to $1.3 million in cash flow. That number is pretty high, and actually crosses the threshold of where Private Equity companies typically seek acquisitions. At that level a buyer would have to have $600,000 for a down payment and about $25,000 a month to cover debt service.
In reality, companies that generate more than $500,000 a year in adjusted EBITDA cash flow (not counting owner compensation) are more commonly sold for multiples of EBITDA. At that size, a multiple of four times adjusted cash flow is pretty common, and would classify a company with up to about $750,000 in adjusted cash flow as “Main Street.”
Mom and Pop Businesses
There is no definition of what is too small to be considered “Main Street,” but I like the description used by Doug Tatum, author of No Man’s Land: Where Growing Companies Fail. Doug says that many entrepreneurs start a company to build wealth. They do all the jobs in the business, and grow it with tireless effort and willingness to work long hours. Eventually, they are earning an income that is three times what they could have made just holding down a job.
Unfortunately, they are earning that income by doing the work of three people. That is my definition of a “Mom and Pop” company. The owner is making a living, but the only way to improve that living is by further denigrating his or her lifestyle.
A local distribution business may have $10,000,000 in revenue, but operates with a half dozen employees and the owners. Their profit before taxes could be as little as $200,000 – putting this $10 million business squarely in the category of “Mom and Pop.”
Mom and Pop business owners are seldom candidates for exit planning. When they stop working, the business ceases to exist. Their best hope is usually to pass it to a family member or employee who is also willing to work really hard to earn a decent living. There is seldom enough free cash flow to support much in the way of debt for the purchase of the company.
Middle Market Businesses
Middle-Market businesses are defined by investment bankers as having revenues between $100 million and $3 billion with less than 2,000 employees. The US Department of Commerce lists the parameters as between $10 million and $250 million in revenue. One accounting association classifies the “lower middle market” as companies between $5 million and $100 million. Investopedia.com pegs it as $10 million to $1 billion. Divestopedia.com goes with $5 million to $500 million. TheStreet.com has the widest range at $5 million to $1 billion.
Of course, a $5 million revenue company could easily have less than $500,000 in pre-tax earnings, which would put it squarely in the Main Street category. On the other hand, a substantial number of software and Internet-based companies have become “unicorns” (over $1 billion in market valuation) with far less than $100 million in revenue.
This discussion is only intended to make two points. First, few people know exactly what they are referring to when they say “Main Street” or “Middle-Market.” They have their own idea and definition, which is fine. Unfortunately, it is unlikely that the person they are talking to has the same definition.
Second, advisors who say they “don’t work with Main Street” are probably uninformed. Many Main Street business owners are excellent candidates for exit planning. In fact, when the $3,000,000 fair market value yardstick is specified, two-thirds of exit planning professionals say that half or more of their clients are in that category i.
(i) 2022 National Exit Planners Survey – exitplannerssurvey.com
This article was originally published by John F. Dini, CBEC, CExP, CEPA on ExitMap.com. John develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.