How Much Is My Business Worth? How the Number Gets Set

The formula

For an owner-operated business with under roughly $5 million in revenue, price is earnings times a multiple. Earnings means seller's discretionary earnings, or SDE. That is the cash the business produces for one full-time owner after you add back the owner's salary, benefits, depreciation, interest, and personal expenses that ran through the company. The multiple is a number, usually between 2 and 4 for main street businesses, that reflects how much a buyer is willing to pay for each dollar of those earnings.

A business with $400,000 in SDE and a multiple of 2.5 is worth about $1 million. That is the starting point for every conversation we have with a seller. Everything else is an adjustment to one of those two numbers.

Larger businesses, usually those with a management team that runs the company without the owner, get valued on EBITDA instead of SDE. The multiples are higher because the buyer is buying a company, not a job. We cover that difference in a separate article. For most of the owners we talk to, SDE is the number that matters.

Where the multiple comes from

The multiple comes from closed transactions in your industry, at your size, over the last few years. BizBuySell publishes aggregate data across thousands of closed sales. DealStats and PeerComps sell access to more detailed transaction records. Lenders who finance acquisitions have their own view of what a business in your category supports.

Across all industries, the median small business has sold for somewhere in the range of 2.5 to 3 times SDE over the last several years. Restaurants sit at the low end. Manufacturing, distribution, and technology businesses sit higher. Home services companies with recurring maintenance contracts have moved up over the last few years because private equity groups started buying them.

We research the multiple fresh for every business we take to market. A number pulled from a different deal, or from a different year, is wrong more often than it is right. The industry, the size of the earnings, the location, and the year all move it.

What moves the number up

Buyers pay more for earnings they trust and earnings they believe will continue after you leave. A few things do most of the work.

Clean financials. Three years of tax returns that match the profit and loss statements, with add-backs that can be documented, will support a higher multiple than a business where the owner says "trust me, it does better than the returns show."

A business that runs without you. If a manager handles the day to day and customers do not call your cell phone, a buyer sees a company. If everything routes through you, the buyer sees a job with risk attached, and prices it that way.

Spread out customers. If no single customer accounts for more than 10 to 15 percent of revenue, losing one does not hurt. If one customer is 40 percent of sales, the buyer will discount the price or structure part of it as an earnout tied to that customer staying.

Recurring revenue. Service contracts, memberships, subscriptions, and maintenance agreements are worth more than one-time project work because the buyer can see next year's revenue before they own the business.

Growth that is still there. A business that grew 10 percent a year for three years gets a better multiple than one that is flat, and a much better one than a business that is sliding.

What moves the number down

The same list in reverse. Messy books, an owner who is the business, one or two big customers, revenue that has to be resold every month, and declining sales all pull the multiple toward the low end of the range or below it.

A few other items come up often. A lease with less than three years left and no option to renew is a problem, because a buyer cannot get a loan against a business that might lose its location. Deferred maintenance on equipment gets priced in. Pending litigation, tax liens, and licensing problems either lower the price or stop the sale.

None of these are permanent. Most of them can be fixed in the six to twelve months before you go to market, and fixing them usually pays better than anything else the owner can do in that year. Adding $100,000 in documented SDE at a 2.5 multiple adds $250,000 to the price.

What about my assets, my brand, my years of work

Buyers of operating businesses pay for earnings. The equipment, inventory, vehicles, and customer list come with the sale, and they support the earnings, but they are not added on top in most cases. A business with $2 million in equipment that produces $150,000 in SDE is worth what the earnings support, and if that is less than the equipment is worth, the owner may do better selling the equipment.

Inventory is the common exception. Many deals are priced plus inventory at cost, counted at closing. Real estate is always handled separately, either sold with the business, leased to the buyer, or kept. We wrote about that as well.

Years of work and reputation show up in the earnings. If the reputation is strong, the business earns more, and the price reflects it. There is no separate line for goodwill on top of a multiple of earnings, because the multiple is already the goodwill.

Asking price versus sale price

A valuation gives you a range, not one number. Within that range, we set an asking price near the top and expect to close somewhere in the middle. Buyers negotiate, lenders appraise, and diligence turns up small things. An asking price set at the expected sale price leaves nowhere to go.

The mistake we see most often is the reverse. An owner sets the asking price at a number that has nothing to do with the earnings, the business sits on the market for a year, and by the time the price comes down, buyers assume something is wrong with it. A business that has been listed for eighteen months is harder to sell at any price than one that just came out.

How to get your number

We run a valuation on the financials, not on a form. Three years of tax returns and profit and loss statements, a current balance sheet, a year to date P&L, and a conversation about what runs through the business that a buyer would not have to pay for. From that we produce a written valuation with the earnings basis, the multiple range with sources, a recommended asking price, and what the owner would net at closing after fees and taxes. There is no charge for it and no obligation to list.

If the number is not what you hoped, you at least know what to fix and how much each fix is worth.