How a Buyer Values a Small Business
How buyers actually arrive at a price for a small Michigan company: the earnings number they start from, the multiple they apply, and the five things that move it.
Most owners I meet have a number in their head before we ever talk. Sometimes it came from a friend who sold, sometimes from an article about a deal ten times their size, sometimes from what they need to retire. The number is not wrong to have. It is just not how a buyer gets to a price.
A buyer starts somewhere else, and if you understand where, the first conversation goes much better.
The starting point is earnings, not revenue
Revenue tells a buyer how big the company is. Earnings tell a buyer what the company is worth.
For most small companies, the earnings figure that matters is adjusted EBITDA: earnings before interest, taxes, depreciation and amortization, adjusted for things that will not continue under a new owner. For very small owner-run businesses, buyers often use seller's discretionary earnings instead, which adds back the owner's own salary and benefits.
Either way, the buyer is asking one question: if I own this company next year, how much cash does it produce?
Adjustments are where the real conversation happens
Almost every owner-run company has expenses on its books that a buyer will add back, and a few that a buyer will take away.
Common add-backs:
- A family member on payroll who does not work in the business
- A vehicle, phone or travel that is really personal
- A one-time legal bill, a move, or a repair that will not repeat
- Above-market rent paid to a building the owner also owns
Common deductions:
- An owner who does the work of two people for no salary. A buyer has to hire someone to replace that.
- Deferred maintenance or equipment that will need replacing soon
- A customer who is leaving, or a contract that is not being renewed
Each add-back needs a paper trail. I explain what a buyer reads first, and how to clean it up, in What a Buyer Actually Looks At in Your Financials. An add-back you can document moves the price. One you cannot document usually does not.
The multiple is a measure of risk
Once a buyer has an earnings figure, they apply a multiple. For established small and lower middle market companies, multiples of adjusted EBITDA commonly fall somewhere in the range of three to six times, and sometimes higher. Very small owner-dependent businesses often trade at lower multiples of seller's discretionary earnings.
Those ranges are wide on purpose. The multiple is the buyer's way of pricing risk. The less likely the earnings are to hold up after the sale, the lower the multiple. The more confident the buyer is, the higher it goes.
Five things that move the multiple
1. How much the business depends on you. If customers call you, suppliers call you, and every decision runs through you, the buyer is buying a job, not a company. A capable second layer of management is worth more than almost anything else on this list.
2. Customer concentration. One customer at 30 percent of revenue makes every buyer nervous. Spread across many customers, the same revenue is worth more.
3. Recurring revenue. Contracts, subscriptions, service agreements and repeat customers who buy every month all reduce the risk that revenue disappears after closing.
4. The trend. Three years of steady growth is worth more than one great year. A buyer pays for where the business is heading, and they read the trend from your numbers, not your forecast.
5. Clean records. Financials that tie to tax returns, contracts that are signed and current, and no surprises in diligence. Surprises do not just lower the price. They make buyers wonder what else they have not found.
Price is not the only term
Two offers with the same headline number can be very different. How much is paid at closing? How much is held back in an earnout or a seller note? What happens to your employees, your name and your role? A slightly lower price with more cash at closing and a clear plan for your people can be the better deal.
At Creek Equity, we buy founder-led and family-owned Michigan businesses and hold them for the long term. We would rather spend an hour walking an owner through how we arrived at a number than send a letter with a figure and no explanation.
What to do before you ask for a number
Start with the five questions in Five Questions to Answer Before You Call a Buyer. Then pull three years of financials, list every add-back with its documentation, and be honest about how much of the business runs through you.
If you would like to talk it through, write to me at scott@creekequity.com. The first conversation is with me directly.
Scott Zack is an investor and entrepreneur in Bloomfield Hills, Michigan and the owner of Creek Equity. He played forward for the Ohio State men's basketball team. About Scott.