HBR vs Stanford Study use of pre or post tax cashflows for debt payments.

February 23, 2021

by a searcher from London Business School in London, UK

Has anyone tried to re-build the financial models in "HBR Guide to Buying a Small Business" or the Stanford search fund primer? In the HBR case do they use free cash flows before taxes to pay down interest and both mandatory and discretionary principal debt payments. In the Stanford case, they are using post-tax for similar payments.

If someone has taken the time to build these out I would love to have a quick chat - happy to share my work as well.

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Reply by a searcher
from London Business School in London, UK

I started this thread to clarify investor's expected returns. It appears the HBR Guide to Buying a Small Business sets this as 25% IRR before tax. The Stanford study is roughly the same, after tax. It would be great to understand on the same basis what investors expect. As investors have different tax situations I imagine the best way to approach this is before tax & then the investors handle their tax situation individually. Which is to say, the Stanford study seems to put the hurdle much higher than the HBR book would suggest.

Reply by a searcher
from Harvard University in Cambridge, MA, USA

If my memory serves me right, I believe the HBR Guide uses pre-tax cash flows to pay down debt because the entity structure is assumed to be an LLC, in which case taxes are paid at the individual shareholder level. I believe (though confirm by asking others) when showing a deal to investors, people show financial projections with debt paydowns assuming cash tax payments at the entity level, even though the entity may be an LLC, to roughly approximate post-tax investor IRRs.

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