I caught up with an entrepreneur friend considering his next thing. He sold his first company and wants to buy a company he can optimize for cash flow. The dilemma he’s working through now is what size company to buy.

If he buys a company that’s over $1 million in annual EBITDA, the multiple paid on EBITDA will be higher. Translation: it will be a much more expensive purchase price, and the yield on the investment likely will be lower than he would like. On the other hand, the company will likely have more people with institutional knowledge of how the business operates. That will minimize the chances of the business rapidly declining if the CEO transitions out. The purchase price will be higher and the yield could be lower, but the business is more likely to run on its own without much intervention from my friend. He could be a passive owner.

If he buys a company with less than $1 million in annual EBITDA, it’s the opposite. The multiple will be lower and the potential yield higher. But there’s key-man risk. The CEO is likely the glue holding it all together. My friend will likely have to become CEO or work closely with the CEO so he can learn the business and minimize the chances of a rapid decline if a CEO transition happens. The purchase price is lower and the yield may be higher, but my friend will likely need to be a very active owner.

Both approaches have pros and cons. I’m curious to see which path my friend chooses.