Profit, Not Sales, Sets the Price
A company with $6 million in sales and thin margins can be worth less than a $2 million company that keeps a third of every dollar.
Buyers ask three things: does the business make money, how much, and how many years of that money are they willing to pay for today?
The number of years is the multiple. The money is the earnings figure. Price is roughly one times the other, and most negotiation is about which earnings figure is real and which multiple fits.
Seller's Discretionary Earnings
For companies where one owner works full time in the business, buyers use seller's discretionary earnings, often shortened to SDE. It answers a simple question: how much could one working owner take home?
The calculation starts with net income on the tax return. Then the owner's salary, payroll taxes on that salary, health insurance, interest, depreciation and any personal costs paid by the company are added back.
Add backs must be real and provable. A one time legal bill qualifies. Cash from selling an old truck does not, because it is not operating income and will not repeat.
EBITDA for Larger Companies
Once a company is large enough that a hired general manager runs it, buyers switch to EBITDA. The owner's role is replaced with a market salary, and what remains is the cash flow an investor would actually receive.
The switch usually happens somewhere around $2 million in purchase price, though it depends on the buyer. Private equity groups almost always think in EBITDA.
A Worked Example
Picture a commercial cleaning company with $1.8 million in sales and $210,000 of net income on its tax return.
- Owner salary and payroll taxes: $120,000
- Owner's health insurance and vehicle: $26,000
- Depreciation and interest: $34,000
- One time legal settlement: $15,000
Those add backs bring SDE to $405,000. At a multiple of 2.5, the company would price near $1 million. With a manager in place and contracts that renew on their own, the multiple might climb toward 3.
What Moves the Multiple
Multiples for small and midsize companies have been fairly steady over time, so waiting a year rarely changes yours much. What does change it is risk.
- Customer concentration: when one to three customers make up more than about 15 to 20 percent of revenue, buyers often cut the price or walk away.
- Owner dependence: if customers call the owner's cell phone, a buyer worries they leave with the owner.
- Records: tax returns that understate income hurt you, because buyers only pay for what they can prove.
- Rent: a lease far below market looks like a perk until the buyer prices the business at market rent.
Our guide to getting your books ready shows how to tighten each of these before a buyer looks.
Real Estate Is a Separate Question
If your company owns its building, the property is valued on its own, using rent and a cap rate instead of a business multiple. Some owners sell both together. Others sell the company and stay on as the landlord, which turns the building into steady income.
Turning a Range Into a Deal
A price range is only useful if buyers can pay it. Many deals under $5 million use an SBA loan plus a seller note, which our page on seller financing and SBA loans explains.
The fastest way to see where your company fits is a conversation with a broker who sees local sales. You can request a confidential valuation or call (719) 555-0172. Colorado filings that come up later are covered under tax and license steps.