01 Oct How Do Buyers Decide What Your Business Is Worth
It’s natural for business sellers to focus on the number they’ll walk away with from the closing table. You know what the business has meant to you, what it took to build, and what you need from the sale to move on.
Buyers are asking a different question: can this business pay for itself and still provide me with a living? To answer that, they need to understand how much the business earns and whether those earnings will continue after you leave.
Start with the earnings
For many small businesses, the starting point is Seller’s Discretionary Earnings, or SDE. We calculate it by adjusting the pretax profit for one working owner’s compensation, interest, depreciation, amortization, and documented expenses that will not continue under new ownership. This gives us a basis for comparing businesses whose owners pay themselves differently or run different expenses through the company.
An add-back has to hold up to scrutiny. Calling an expense personal or one-time doesn’t make it so. A buyer will want to know what it was, why it happened, and whether it will actually go away.
We look at what similar businesses have sold for relative to their earnings to establish a range of value. The comparisons are imperfect, especially for unusual businesses or markets with few comparable sales. We also have to consider the business itself, including its earnings trend, customer relationships, lease, and how dependent it is on you.
Two businesses with the same SDE can warrant different prices. One may have reliable staff and a broad customer base. The other may depend on the owner for nearly every sale or rely heavily on a single customer. The buyer is taking on different risks.
What changes when you leave
The earnings on paper may include benefits that won’t convey to a buyer. If your spouse handles the bookkeeping without being paid, or your children pitch in during the busy season, someone will have to do that work after the sale. Paying for it reduces the earnings available to the buyer.
The same applies if you own the building and the business pays little or no rent. If you plan to charge the buyer market rent, that expense needs to be included when evaluating the business. A business purchased with its real estate also needs to be evaluated with the cost of occupying and financing the property in mind.
A required license presents a different problem. If the business operates under your personal license, the buyer needs a way to meet that requirement. Your departure may create an expense, a delay, or a barrier to operating at all.
This is what we mean by transferable value: what the buyer can reasonably expect to retain once you are no longer there. Customer loyalty, staff experience, vendor relationships, and operating procedures all matter. So does whether those relationships and procedures belong to the business or depend entirely on you.
What about the potential
Every owner sees potential in their business: a second location, a service they never had time to add, a marketing push that would bring in new customers. That potential may be real. It can give a buyer a reason to choose your business.
But growth the buyer creates comes from the buyer’s money, time, and risk. Very few will pay you in advance for work they’ll be doing. Even fewer will pay for the experience or connections they bring with them.
Documented demand, signed contracts, or an expansion already producing results give a buyer more to evaluate than an idea you have yet to pursue. The stronger the evidence, the stronger your case.
The price also has to work
Once we have a proposed price, we test whether the business can support the financing a buyer is likely to need. The buyer has to cover loan payments, operating needs, and a reasonable income. If the numbers only work when the buyer works for free, we have a problem.
At Sam Goldenberg & Associates, we work through these questions before taking a business to market. We establish the earnings, examine what will change under new ownership, and test the asking price against a financing scenario. That gives us a price we can explain and support when a buyer asks how we arrived at it.
