Evaluating a small business for sale: a one-hour screen
Short answer
To evaluate a small business for sale quickly, check six things: the asking price relative to the stated cash flow (and whether that's SDE or EBITDA), how much the business depends on the owner, customer concentration, the three-year revenue and earnings trend, lease terms, and any obvious red flags in the listing or CIM. If it passes, request tax returns and bank statements and do a proper earnings check.
The goal of the first hour isn't to value the business. It's to decide whether it deserves more of your time.
You'll look at far more businesses than you'll ever pursue. A disciplined one-hour screen saves weeks.
The six checks
| Check | Look at | Pass | Pause |
|---|---|---|---|
| 1. Listing math | Asking ÷ cash flow; is it SDE or EBITDA; inventory in or out? | In line with similar listings | Far above, or "cash flow" undefined |
| 2. Owner role | Owner hours and duties | Manager-run or owner manages | Owner does sales, service or holds licence |
| 3. Customers | Concentration hints | Many customers | One big contract or customer |
| 4. Trend | 3 years of revenue and earnings | Stable or growing | Declining, or one great year |
| 5. Lease | Years left, options, rent | Long, assignable | Short or unknown |
| 6. Red flags | Vague add-backs, "cash business", no returns | None | Any |
Worked example: screening a listing in an hour
Illustrative listing, not a real business
"Established HVAC company, $1.6M revenue, $420,000 cash flow, asking $1.5M, semi-absentee, 9 employees, owner retiring." Check 1: price is 3.6x the stated cash flow; ask whether $420,000 is SDE and what's in it. Check 2: "semi-absentee" plus a retiring owner: ask what he does each week and who holds the contractor licence. Check 3: residential HVAC usually has many customers; ask whether any builder or property manager is large. Check 4: ask for three years of revenue and SDE. Check 5: ask how long the lease runs. Check 6: ask whether tax returns support the $420,000. Then a quick financing test: if verified SDE were $420,000, you took $110,000 and reserved $30,000 for trucks, $280,000 would be left for debt. A $1,350,000 loan at an example 10.5% over 10 years costs about $218,600 a year, coverage of 1.28. Workable on paper, if the $420,000 holds. If it's really $360,000, coverage falls to about 1.01. So the one question that matters most is how much of the $420,000 is documented.
Questions to send after a listing passes the screen
- Can you send the calculation behind the cash flow figure, line by line?
- Can you send three years of tax returns and year-to-date financials after an NDA?
- What does the owner do each week, and who would do it after the sale?
- What share of revenue comes from the largest five customers?
- When does the lease end, and are there renewal options?
- Why is the owner selling, and how long has the business been on the market?
Kill criteria: decide before you look
Most buyers say yes to a deal too slowly and no too late. Writing down a short list of kill criteria before you open the first listing makes the one-hour screen faster and less emotional. Examples (set your own): no three years of tax returns; asking price that only works with add-backs the seller can't document; one customer over 30% of revenue with no contract; the owner is the only licensed person and won't stay; lease under five years with no options; revenue down two years in a row without a clear, fixable cause. A deal that hits one criterion gets a single question to the broker. A deal that hits two gets a polite no.
After the screen
For businesses that pass, the next step is the earnings check: tax returns vs P&L vs bank deposits, and rated add-backs. That's where most deals change shape. See proof of cash and add-backs.
How to read a business for sale listing
A business-for-sale listing usually shows an asking price, 'cash flow' (almost always seller's discretionary earnings, including the seller's add-backs), gross revenue, the value of furniture, fixtures and equipment (FF&E), whether inventory is included, whether real estate is included or leased, and whether seller financing is available. Each field is the seller's claim, not a verified fact.
The two questions to ask first: what exactly is 'cash flow', and what does the price include?
Listings are short advertisements. Knowing exactly what each field usually means lets you compare them properly and ask better first questions.
Field by field
| Field | Usually means | Ask |
|---|---|---|
| Asking price | Seller's opening position | How was it set? |
| Cash flow | SDE including all seller add-backs | The calculation, line by line |
| Gross revenue | Latest year or TTM sales | Which period? Trend? |
| FF&E | Seller's estimate of equipment value | Equipment list with ages |
| Inventory | Stock, included or on top | Count method and cap |
| Real estate | Owned (maybe separately) or leased | Lease term, rent, assignment |
| Seller financing | Seller may carry a note | Amount, rate, term; standby? |
| Employees | Headcount, often excluding owner | Who's key; will they stay? |
| Reason for selling | Seller's stated reason | Does the trend fit the story? |
The CIM, which comes after the NDA, has more detail; see reading a CIM.
Listing phrases and what to ask
| Listing says | Often means | Ask |
|---|---|---|
| "Semi-absentee" | Owner works fewer hours, but still works | What does the owner do each week? |
| "Turnkey" | Systems exist; may depend on the owner | Who runs it when the owner is away? |
| "Room to grow" | The seller didn't do it | What was tried, and what happened? |
| "Cash flow" | Usually SDE including all add-backs | Line-by-line calculation |
| "SBA pre-qualified" | A lender looked at summary numbers | Which lender, on what documents? |
| "Motivated seller" | A reason to sell soon | What's the reason, and does the trend fit? |
| "Seller financing available" | Seller may carry a note | Amount, terms, and standby if SBA |
Your evaluation file
Keep the same short file for every business you look at seriously. It lets you compare deals side by side and shows a lender you work methodically.
Business: [name, industry, location]
Asking price and what's included: [price; inventory, real estate, working capital]
Revenue, three years: [per tax returns]
SDE as listed, and as you rebuilt it: [both figures]
Add-backs you couldn't support: [list]
Coverage at the asking price: [DSCR from your model]
Three things diligence must confirm: [list]
Kill criteria triggered: [none, or which]
Decision and date: [pass / LOI / more questions]
Use the debt service coverage calculator for the coverage line.
Three questions to answer before you spend money
Once a listing passes the screen, diligence starts costing real money: attorney time, an accountant's review, lender fees. Before you spend any of it, you should be able to answer three questions in a sentence each. Why does this business earn what it earns? What could stop it earning that under you? What would you do differently in the first year? If you can't answer the first, ask the seller more questions. If you can't answer the second, you don't know the risks yet. If the third is "nothing", make sure the price assumes nothing changes.
Keep your evaluation files even for deals you pass on. Over a few months, they show which kinds of listings waste your time, and which brokers send numbers that hold up.
When a listing gives only revenue and a cash flow figure, ask which year it covers, whether it is SDE or EBITDA, and how much owner pay is already in it. Those three answers change how the figure compares with any other listing, and they cost the broker nothing to give.
Frequently asked questions
What's the first number to look at?
Asking price divided by the stated cash flow, and what that cash flow includes. It tells you whether the seller's expectations are in a sensible range.
How do I judge owner dependence quickly?
Look for clues in the listing and CIM: does the owner do sales, service or hold the licence? 'Owner works 60 hours' is a different business from 'managed by GM'.
When should I move past the screen?
When the numbers look sensible, the business fits your buy box, and there's no deal-breaker. Then sign an NDA and request financials.
Should I value the business at this stage?
No. Screen first; verify earnings next; think about price only after that.
What does 'cash flow' mean on a business listing?
Usually seller's discretionary earnings: profit plus one owner's pay, interest, depreciation and the seller's add-backs. Ask the broker to confirm and show the calculation.
What is FF&E?
Furniture, fixtures and equipment. Listings often show a value, typically the seller's estimate. It's usually included in the asking price.
Sources
Related guides
General information, not legal, tax, financial or investment advice. Rules and lender practices change; check the linked sources and talk to your attorney, CPA and lender about your deal. Examples with named numbers are illustrations, not real businesses. OKtoBuy's Deal Check does not value businesses or give price opinions.