Can I Sell My Business After a Down Year?

How buyers read the numbers

Buyers do not look at one year in isolation. They look at three to five years of tax returns and financial statements, and at the trailing twelve months, usually written TTM, which is the most recent twelve months of results regardless of where the calendar year ends. TTM matters because it shows where the business is now.

They are looking for a trend. A business that earned $900,000 two years ago, $600,000 last year and $850,000 over the most recent twelve months tells one story. A business that went $900,000, $750,000, $600,000 tells another. The first had a bad year. The second is declining, and buyers will price it as declining.

Why the year was down matters most

A buyer's first question is what happened. The answers sort into two groups.

The first group is causes that are over and will not come back. A one-time loss of a large project that was never going to repeat. A key employee who left and has been replaced. A major equipment failure that shut down production for a quarter and is now fixed. A move to a new location that cost a few months of sales. A family illness that took the owner out of the business for part of the year. Buyers accept these when the records show the cause and show the recovery.

The second group is causes that may still be there. A competitor took share. A big customer left and was not replaced. Margins dropped because costs went up and prices did not. The industry is shrinking. These are harder, because the buyer has to assume the lower number is the new normal, and they will.

Most down years have some of both. Our job is to sort out which is which before a buyer does it for you.

How valuation handles it

Most small and mid-sized businesses are valued as a multiple of earnings, either seller's discretionary earnings or adjusted EBITDA. Seller's discretionary earnings, or SDE, is what a full-time owner takes out of the business, including their own pay. Adjusted EBITDA is earnings before interest, taxes, depreciation and amortization, plus add-backs for expenses a new owner will not carry. We cover both in SDE vs. EBITDA.

After a down year, the earnings figure the price is built on gets harder to agree on. A seller wants the buyer to use the strong years. A buyer wants to use the weak one. Common middle grounds are a weighted average of the last three years, with more weight on the most recent, or a normalized figure that adds back the specific, documented cost of the event that caused the drop. A normalized figure only works if the cost is clearly one-time and the paper backs it. A seller who tries to add back the entire decline as "one-time" without evidence loses credibility on every other number.

The multiple can move too. A buyer who is less sure about future earnings will often apply a lower multiple, on top of a lower earnings figure.

How lenders see it

Many buyers of businesses under roughly $5 million use SBA loans, bank loans backed by a guarantee from the U.S. Small Business Administration. SBA lenders underwrite mostly from tax returns, and they want to see that the business's cash flow covers the loan payments with a cushion. A down year on the most recent tax return can shrink the loan a lender is willing to make, which shrinks what the buyer can pay. A strong TTM helps, though lenders vary in how much weight they give interim results that are not yet on a tax return. More on how those loans work in SBA Loans in Business Acquisitions.

Structure can close the gap

When the seller believes the recovery will hold and the buyer is not sure yet, deal structure is often how the two meet.

An earnout is the part of the price that gets paid after closing only if the business hits agreed targets. If you believe earnings are back to where they were, an earnout tied to those earnings lets the buyer pay for the recovery once it shows up. Earnouts carry risk for the seller because the buyer runs the business after closing, and we explain how to protect yourself in Earnouts, Holdbacks, and Working Capital Pegs.

A seller note, where you finance part of the price and the buyer pays you back over time, can also help, because it lets a buyer pay a higher total price without needing a larger loan. See Seller Financing for the protections that should come with one.

A worked example

Take a hypothetical commercial landscaping company. SDE was $700,000 two years ago, $480,000 last year, and $660,000 over the most recent twelve months. The drop came from losing a large municipal contract that ended when the city brought the work in house. The owner replaced most of that revenue within nine months with three new property management accounts.

A buyer using only last year's figure would build the price on $480,000. A buyer using a weighted average, with half the weight on the most recent twelve months and a quarter on each of the two years before, would land at about $625,000. The seller would like the price built on $700,000.

A reasonable deal might set the cash price on something close to the weighted figure and add an earnout that pays more if the new accounts renew and SDE stays above $650,000 in the first year after closing. The buyer pays for what is proven. The seller gets paid for the recovery if it holds. The records that make this work are the city's notice ending the contract, the signed contracts with the three new accounts, and monthly statements showing the revenue coming back.

When waiting makes sense

Sometimes the right advice is to wait. If the business is mid-recovery and the next six to twelve months will show it clearly on paper, waiting can be worth a good deal of money, because buyers pay for results they can see. Businesses sell best on the way up.

Waiting has costs too. Markets change, interest rates change, and the owner's energy runs out. An owner who is burned out and waits two more years often runs the business worse during that time, which defeats the purpose. We usually build two scenarios for an owner in this spot, a sale now and a sale after a set recovery period, with the expected net proceeds for each.

What to prepare

A short written explanation of the down year, with the cause, what was done about it and the evidence. Monthly financials for the last 24 to 36 months, so the recovery is visible month by month instead of buried in an annual total. Documents for any normalizing adjustment, such as invoices for the equipment repair or records of the lost project. Current pipeline or backlog figures if the business has them, since they show where the next twelve months are heading.

Buyers will find the down year in the first set of numbers they see. Showing it to them first, with the explanation and the records attached, is the version of this conversation that goes best.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.