How to analyze a small business acquisition

Buying a small business is one of the most binding financial decisions you will ever make. You often put your savings into it, sometimes your house as collateral, and unlike a stock position, you cannot sell out the next morning if you got it wrong. Analyzing a target is therefore not an exercise in trusting the seller. It is a discipline of structured skepticism. A sale memorandum is always written to sell: revenue is growing, margins are solid, the order book is full. Your job is to take that story apart, layer by layer, until you reach the economic reality of the business. Four layers, in order. It is the same acquisition due diligence we run alongside buyers of SMEs and startups.

1. Normalized earnings: what you are really buying

The price is almost always a multiple of EBITDA. But the EBITDA shown in the memorandum is rarely the one you will inherit. Your first task is to normalize it, that is, to bring it back to the real, recurring profitability the business will generate once you take over. In a founder led SME or startup, the gap between reported and normalized EBITDA often exceeds 20 percent, in either direction.

• Owner salary: if the founder pays themselves 60,000 euros while you will need to hire a manager at 160,000, deduct 100,000 euros. If instead they drew 300,000 for tax reasons, you can add part of it back.
• Private spending booked as expenses: car, travel, meals, personal subscriptions. These padded the seller’s comfort, not the value of the business. Add them back only if they can genuinely be removed.
• Below market rent: if the business rents its premises from the seller’s property company at a favorable rate, correct it to market, because that is what you will pay.
• Exceptional items: a large one off order, a won lawsuit, a single grant. They must not sit in the earnings to which you apply a multiple.

You are not buying last year’s profit, you are buying the company’s ability to generate that profit without the seller, next year and the years after that.

Once EBITDA is normalized, examine its quality. A profit of 500,000 euros built on forty recurring customers under contract is not worth the same as a profit of 500,000 euros carried by two large clients the founder manages personally. The first deserves a full multiple, the second a discounted multiple and a deferred earnout. The trajectory matters too: three years of stable or growing margin reassure, while a margin that has eroded for two years is a warning the memorandum will try to hide behind a recent peak.

2. Quality of revenue: recurrence and concentration

Total revenue lies more often than profit does. Two businesses with 3 million in revenue can be radically different assets. Ask yourself three questions. How much of the revenue is recurring or contractual, and how much must be won again from scratch every year? How concentrated is it: if the top three customers exceed 50 percent of revenue, losing a single one can wipe out the very profitability you have just paid for. And who owns the relationships: the contracts and the team, or the founder’s handshake, which walks out the door within twelve months?

Ask for the customer list over three years, anonymized if needed, and calculate the retention rate yourself. High churn masked by fresh customers every year means you are buying a machine for replacing lost clients, not a stable base. Check the major contracts for change of control clauses too: a contract that lets the customer walk away the day you take over the business is not an asset, it is a disguised liability.

3. Hidden risk: what the balance sheet does not show

After profitability and revenue, hunt for latent liabilities. These are the surprises that always show up after closing, never before, and turn a good deal into a sinkhole. Working capital is the most common trap. I have watched a buyer discover in the first month that he had to inject nearly as much working capital as he had paid for the business, simply because it pays suppliers in 30 days and collects from customers in 90. A company that is profitable on paper can absorb cash continuously for that reason alone. Buy it with no cash and no debt, and that working capital comes straight out of your pocket, on top of the price.

• Technical debt and deferred investment: machinery at the end of its life, obsolete IT, unmaintained software. These are costs the seller avoided and that you will pay for right after takeover.
• Employment liabilities: unprovisioned overtime, accrued holiday, the possible reclassification of contractors as employees, social security compliance going back several years.
• Tax risk: VAT, aggressive deductions, transfer pricing between related companies. Any quantifiable potential reassessment must be covered by a liability warranty or a price holdback.
• Ownership of key assets: brand, domain name, source code, patents. Verify that they belong to the company being sold, not to the founder personally.

The method for missing nothing comes down to a simple discipline: ask, then cross check. Everything the seller asserts out loud must be verified against a document: a contract, an invoice, a tax return, a bank statement. When a figure in the memorandum does not reconcile with the audited accounts or the VAT returns, that is not a detail, it is the thread to pull.

4. Price: from multiple to payment structure

Once the first three layers are understood, the price becomes a calculation, not a hunch. Start from normalized EBITDA and apply a multiple consistent with the sector, the size and the risk. For a well diversified Swiss services SME or startup, multiples of 4 to 6 times EBITDA are common; a founder dependent or client concentrated business trades below that. Remember that every 100,000 euro adjustment to EBITDA moves the price by 400,000 to 600,000 euros: the rigor of layer 1 pays off directly here.

But the multiple is only half the equation. Enterprise value is generally computed on a cash free, debt free basis: you take over the business without the excess cash or the financial debt, then adjust for a normative level of working capital. Never sign a price without defining that normative level, otherwise the seller will drain the operating cash before closing and leave you to fund the restart.

The payment structure is your best protection against uncertainty. Rather than paying 100 percent in cash, spread the risk: an upfront payment, a vendor loan over two to three years, and an earnout indexed to client retention or EBITDA maintenance. This structure aligns the seller’s interest with the real continuity of the business and reduces your exposure if reality proves less attractive than the memorandum suggested. Finally, validate the price with the most concrete test there is: after servicing the acquisition debt, paying yourself and keeping a cash cushion, does the business still generate cash, yes or no? If the answer is no, the price is too high, whatever the theoretical multiple.

This four layer analysis separates good acquisitions from costly mistakes, but it takes craft: knowing where the numbers hide, which questions force the answers, and how each flaw translates into price. If you are studying a target right now, have the file reviewed before the letter of intent: structured business acquisition analysis by an outside eye keeps you from paying for a risk you never saw coming.

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