Start With Cash Flow, Not Sales
Two companies can each bill $4 million a year and be worth wildly different amounts. One keeps $700,000. The other keeps $180,000. Buyers price the money a company keeps, so sales are just the starting line.
That is why the first thing a broker asks for is three years of tax returns and profit and loss statements. Those documents set the base the rest of the math is built on.
Seller's Discretionary Earnings
For most owner run companies selling under about $2 million, buyers measure profit as seller's discretionary earnings, or SDE. It answers a simple question. How much could one full time owner take home?
The math starts with net profit on your return and adds back items a new owner would not carry the same way:
- Your salary and payroll taxes on it
- Health insurance and retirement contributions for you
- Interest and depreciation
- Personal costs paid by the company, such as a family phone plan
- Truly one time costs, like a lawsuit settled years ago
Addbacks buyers will challenge
Every addback needs paperwork. A buyer's accountant will ask for receipts, and anything that looks like a normal cost of running the place gets taken back out. Repairs that happen every year are not one time, even if they felt like it.
The same goes for income. Money from selling an old truck or a loan deposit is not operating profit, and cash that never hit the books cannot be proven, so it does not count at all.
When Buyers Switch to EBITDA
Once a company is big enough that a hired manager runs it, buyers look at EBITDA instead. That is earnings before interest, taxes, depreciation and amortization, after paying everyone, including a fair salary for the person in charge.
Private equity groups usually start paying attention somewhere around $750,000 to $1 million of EBITDA, sometimes lower for a strong company. Their offers are often structured differently, with part of the price tied to future results.
The Multiple
The multiple is how many years of cash flow a buyer will pay up front. Many established Main Street companies sell for roughly two to three times SDE. Larger, less risky companies can go higher on EBITDA.
Multiples are steadier over time than most owners expect. Waiting a year rarely buys a better one. Improving the company usually does.
What lowers a multiple
- A few customers holding more than about 15 to 20% of revenue
- An owner who personally does the selling, estimating or key work
- A lease ending soon, or below market rent that will reset
- Results that fell recently, or jumped right before the sale
- Books that disagree with the tax returns
What raises it
- Recurring revenue, like service agreements or monthly routes
- A team that stays and runs things through the transition
- Clean records and documented processes
- Room to grow that a buyer can see without much risk
A Quick Example
Say a Mesa company shows $260,000 of net profit. The owner pays herself $120,000, the company covers $18,000 of her health insurance, and depreciation is $32,000. Her SDE is about $430,000.
At two and a half times, that suggests a price around $1.075 million before terms. If one customer is 30% of sales, the buyer may lower the multiple or ask for part of the price as an earnout.
Terms Change What You Keep
A headline price is only part of an offer. How it is paid matters too: cash at closing, an SBA loan, a seller note, or money that depends on future results. Two offers for the same price can be worth very different amounts to you.
See preparing your company for sale for ways to raise your multiple before you list, and how a sale unfolds for where pricing fits in the process.
Taxes on the gain often cost more than any fee, so also read our sale paperwork guides and talk with your CPA early.
For your own numbers, send the form or call (480) 555-0124.