Most owners have a number in their head. It might come from a friend’s sale, a rule of thumb heard at a trade show or simply what they’d need to retire comfortably. The number a buyer would actually pay is often different, sometimes higher and sometimes lower, and it helps to know which well before you have to decide anything.
Why it’s worth knowing now
A sense of value isn’t only useful on the day you sell. It feeds into plenty of decisions you’re already making:
- whether your retirement plan works, and how much of it depends on the business;
- how to handle a partner who wants out, or a family member who wants in;
- how to respond if a competitor or investor calls with an unsolicited offer;
- which improvements are worth your time over the next few years.
If you know where you stand, you can plan around a realistic figure instead of a hopeful one.
Buyers start with earnings, not your tax return
A buyer is paying for the cash the business will produce in the future, so the starting point is what it earns today. But the profit on your financial statements is rarely the right figure. Most private companies are run to keep taxes reasonable and to suit the owner, which is perfectly sensible but makes the numbers harder for an outsider to read.
So the first step is to normalize the statements. That means adding back items that won’t continue under a new owner: personal expenses run through the company, one-time costs and anything unrelated to operations. It also means adjusting your own pay to what it would cost to replace you.
Here’s a simplified, hypothetical example for a business reporting $300,000 of pre-tax profit.
| Item | Amount |
|---|---|
| Pre-tax profit as reported | $300,000 |
| Add: interest | $20,000 |
| Add: depreciation and amortization | $60,000 |
| Add: owner pay above the cost of a replacement manager | $50,000 |
| Add: personal expenses paid by the company | $25,000 |
| Add: one-time legal settlement | $35,000 |
| Adjusted EBITDA | $490,000 |
Every adjustment needs to be supported. Buyers and their accountants will test each one, and add-backs that can’t be explained tend to disappear in negotiation.
SDE for smaller firms, adjusted EBITDA for larger ones
For smaller, owner-operated companies, buyers usually look at seller’s discretionary earnings (SDE), which adds back all of the owner’s pay because the buyer will often step into that role. For larger businesses with a management team in place, adjusted EBITDA is more common. The difference matters, because the same business can look quite different depending on which measure is used. Our article on SDE and EBITDA explains how each works.
What moves value up or down
Once earnings are clear, the question becomes how much a buyer will pay for them. That depends on what similar businesses have sold for and, just as much, on how risky your earnings look. Two companies earning the same amount can be worth quite different sums.
The points buyers look at most closely include:
- Customer concentration: if one or two customers make up a large share of sales, losing one is a serious risk.
- Reliance on you: if key relationships, pricing or know-how sit with the owner, a buyer has to wonder what leaves when you do. Would your business run without you? covers this in detail.
- Recurring revenue: contracts, repeat orders and service agreements make future cash flow easier to predict.
- Equipment and facilities: worn-out machinery means a buyer faces spending soon after closing.
- Working capital: businesses that tie up a lot of cash in inventory or receivables need more funding to run.
- Industry outlook: where your sector is heading affects how confident buyers feel about the next five years.
Why you get a range, not a number
In the end, value is what an actual buyer agrees to pay, and on what terms. Different buyers see different things in the same business, and the structure of an offer can matter as much as the headline price. That’s why a realistic view of value is given as a range.
To continue the hypothetical example: if buyers for a business like this were paying somewhere between three and four times adjusted EBITDA, the range would be roughly $1.5 million to $2 million. Those multiples are for illustration only. The right ones for your business depend on its size, sector and risks.
An advisor’s view of value is meant for planning and for preparing a sale. It isn’t a report prepared for tax, court or estate purposes, which have their own requirements. If you need one of those, your accountant can tell you what’s involved. You can read more about how we approach this on our valuation page.
What to do with the answer
If the range is close to what you need, you have options and can choose your timing. If it’s below, the list of value drivers above is a good place to start. Some of those points take years to change, so it helps to know early which ones matter most for your business.
Find out what your business is worth while you still have time to do something about it.
Start by pulling together your last three years of financial statements and a list of the personal and one-time expenses you know are in them. That alone will tell you a good deal about how a buyer would read your numbers.
General information for business owners and buyers, not financial, legal, tax or accounting advice. Any examples are hypothetical.
