What Is Weighted Average Cost of Capital (WACC) — and Why It Matters When Buying a Small Business

Today, we’re diving into a super important topic: the Weighted Average Cost of Capital, or WACC. If you're looking to buy a small business, understanding WACC helps you figure out whether it's a good idea to put your money—or the bank’s money—into the deal. https://youtu.be/vTsIwe_If88

So... What Is WACC?

The Weighted Average Cost of Capital is essentially a way to determine how much of a return you require on the money invested in a business.

This includes:

• Money you borrow (like a bank loan)
  
  

• Money you invest yourself (your equity)
  
  

Each type of capital comes with a cost:

• Banks want interest on their loans.
  
  

• You (the buyer) should want a return on your own capital—because your money could be earned elsewhere.
  
  

Setting the Stage: A Simple Balance Sheet

Let’s take a quick look at a basic balance sheet.

On the liabilities and equity side:

• Trade payables (short-term debts like accounts payable) are usually not included in WACC.
  
  

• What is included:
  
  

• Interest-bearing debt (long-term loans)
  
  

• Equity, which includes:
  
  

• Owner's contributions (even if they’re listed as loans on paper)
  
  

• Share capital (often nominal in small businesses)
  
  

• Retained earnings (profits from prior years left in the company)
  

For simplicity, let’s assume:

• $50,000 in long-term debt
  
  

• $50,000 in owner's equity
  

That gives us a 50/50 split between debt and equity—something many banks like to see.

Calculating WACC — The Real Math

Let’s say the bank is lending at 6% interest, and you (the buyer) want a 45% return on your invested equity.

Step-by-step:

• 50% of the capital is debt → 0.5 × 6% = 3%
  
  

• 50% of the capital is equity → 0.5 × 45% = 22.5%
  
  

• Add those together: 3% + 22.5% = 25.5% WACC
  

So, your Weighted Average Cost of Capital is 25.5%.

That means you’d need the business to generate a return of at least 25.5% just to make your investment worthwhile—not to mention profitable.

But What If You Use More of Your Own Money?

Let’s say:

• You reduce the debt to $25,000
  
  

• Increase equity to $75,000
  

Now the math changes:

• 25% debt → 0.25 × 6% = 1.5%
  
  

• 75% equity → 0.75 × 45% = 33.75%
  
  

• Add them: 1.5% + 33.75% = 35.25% WACC
  

👉 So the more of your own money you put in, the higher your required return becomes.

Key Insight:

That accountant telling my client, “Just put in more of your own money,” missed the point. More equity = higher required return = tougher investment to justify.

It’s also a good reminder why vendor financing is so important in small business deals. Banks might not fund the whole purchase price, and you don’t want to sink too much of your own money in either.

Final Thoughts

If you’re buying a small business, never forget that your own capital has a cost too—even if nobody sends you an interest invoice every month. And don’t fall for the advice that says “just put in more of your own money” if the deal isn’t producing enough return. That only makes things worse unless you’re willing to accept a lower rate of return.

I hope this helped demystify WACC a bit. I’ll be referencing it more in upcoming videos and posts, so now you’re in the loop!

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Cheers, and see you next time!

David C. Barnett