How to Determine the Right Offer

Buying Basics: How to Determine the Right Offer When Purchasing a Funeral Home

Once you’ve identified a funeral home you’d like to purchase, the next critical step is determining how much to offer. While there are exceptions to every rule, this guide will provide you with general guidelines on how to make a competitive and financially sound offer. These guidelines assume that you’ll be securing bank financing, have excellent credit, relevant industry experience, and are prepared to make a modest down payment. Additionally, we’ll explore how seller financing might align with bank terms and how to assess the overall value of the business.

Understanding Seller’s Discretionary Earnings (SDE)

When evaluating a business, one of the most important metrics to consider is the Seller’s Discretionary Earnings (SDE). SDE represents the total cash flow available to the owner and is calculated by adding together several components:

• Business Profit or Loss: The net income of the business after expenses.
• Owner’s Salary: The compensation paid to the current owner.
• Discretionary Expenses: Non-essential expenses that the owner chooses to incur, such as personal perks.
• Non-Recurring Expenses: One-time costs that are not expected to continue.
• Non-Cash Expenses: Items like interest, depreciation, and amortization.

In the funeral industry, businesses typically sell for a multiple of SDE, usually in the range of four to six times. This price range generally includes all operating assets of the business, such as real estate, equipment, and inventory.

How to Calculate Your Offer

Your offer should be based on how much cash flow the business generates and how much of that cash flow will be available to service the debt after the purchase. Here’s a step-by-step guide to calculating a realistic offer:

1. Calculate Cash Flow Available for Debt Service (CDS)

Start by calculating the cash flow available to service the debt. This is done by subtracting the minimum salary you’ll need to cover your personal living expenses from the SDE.

For example, if the business’s SDE is $350,000 and you require a personal salary of $50,000, the CDS would be:

$350,000 (SDE) – $50,000 (Personal Salary) = $300,000 (CDS)

2. Understand the Debt Coverage Ratio

Most lenders will require a margin of safety when calculating how much debt the business can support. This is typically expressed as a debt coverage ratio, which ensures that the business generates more cash flow than is required to cover debt payments.

If a lender requires a debt coverage ratio of 1.5, you would divide the CDS by this ratio to determine the maximum annual debt payment:

$300,000 (CDS) ÷ 1.5 (Debt Coverage Ratio) = $200,000 (Maximum Annual Debt Payment)

3. Determine the Loan Amount

Once you know the maximum annual debt payment, you can calculate the total loan amount you can secure based on the interest rate and loan term. For example, if the loan is amortized over 15 years at an 8% interest rate, the $200,000 in annual debt payments would support a loan of approximately $1.7 million.

4. Factor in the Down Payment

Finally, add your down payment to the loan amount to determine your total offer. If you plan to put down $300,000, you could offer approximately $2.0 million for the business:

$1.7 million (Loan Amount) + $300,000 (Down Payment) = $2.0 million (Total Offer)

Key Considerations When Making an Offer

When making an offer, it’s important to consider the following factors to ensure your offer is both competitive and financially viable:

Industry-Specific Multiples

The funeral industry typically sees businesses selling for four to six times SDE. However, the specific multiple within this range can depend on factors such as the business’s location, growth potential, and market conditions.

Seller Financing Terms

If the seller is offering financing, ensure that the terms are comparable to what you would get from a bank. This includes interest rates, loan terms, and any potential risks associated with seller financing.

Asset Valuation

Ensure that the value of individual assets, such as real estate and equipment, does not exceed the overall value of the business. Overpaying for assets can lead to financial strain down the line.

Example Scenario

Let’s apply these principles to a hypothetical scenario:

• Business SDE: $350,000
• Personal Salary Requirement: $50,000
• CDS: $300,000
• Debt Coverage Ratio: 1.5
• Maximum Annual Debt Payment: $200,000
• Loan Amount: $1.7 million
• Down Payment: $300,000
• Total Offer: $2.0 million

In this scenario, you could confidently offer $2.0 million for the funeral home, knowing that the business’s cash flow supports the necessary debt payments while also providing for your personal salary needs.

Conclusion: Making a Well-Informed Offer

Determining how much to offer when purchasing a funeral home involves careful calculation and consideration of both financial and industry-specific factors. By understanding SDE, calculating cash flow available for debt service, and working with realistic debt coverage ratios, you can make an informed offer that aligns with both your financial goals and the business’s long-term viability.

Ready to make an offer on a funeral home?

Contact us today for personalized guidance on making the right financial decisions during your business purchase. Explore our resources to learn more about valuation, financing, and negotiating the best deal.

For expert advice on buying a funeral home and making the right offer, contact Matt Manske, Managing Member of BSF LLC, at (913) 343-2357 or via email at [email protected]. Visit www.4BSF.com for more information.

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