What Increases a Business's Valuation?

How a sale price is built

Before you can raise your value, it helps to know how a buyer arrives at a price. The SBA describes three broad ways to value a business: an income approach that looks at projected revenue and accounts for potential risks, a market approach that compares your business to similar businesses that have recently sold, and an asset approach that subtracts total liabilities from the value of all assets [1]. For most profitable small and mid-sized businesses, buyers lean on the market approach in a simple form: an earnings figure times a multiple.

The earnings figure is usually seller's discretionary earnings (SDE) for smaller, owner-run businesses and EBITDA for larger ones with a management team. It starts from your books, then the buyer accepts or rejects your adjustments. The multiple reflects how risky and how durable the buyer thinks those earnings are. If you are not sure which measure applies to you, read SDE vs EBITDA.

The third piece is terms. Two offers with the same headline price can be worth very different amounts to you, depending on how much is paid in cash at closing, how much is deferred into a seller note, how much depends on an earn-out, and what working capital you leave behind. When buyers see risk they can't price into the multiple, they often push it into the terms instead.

So every value driver on this page works through one of three levers: it changes the earnings figure the buyer accepts, it changes the multiple the buyer is willing to apply, or it changes how much of the price you actually receive at closing. The table above says which lever each factor mostly pulls. To see where your own numbers land, the value range calculator applies sector and size medians to your earnings, and asking price vs sale price explains why the number on a listing and the number at closing differ.

Owner dependence: the most common discount

A buyer is paying for the business that remains after you leave, not for your personal effort. If you are the one who wins the work, prices the jobs, keeps the big customers happy and solves every problem, the buyer has to ask how much of the profit leaves with you. The honest answer is usually some of it, and buyers protect themselves against that uncertainty.

Owner dependence rarely shows up as a single line in the financials. It shows up in diligence conversations. Who do customers call when something goes wrong? Who signs off on quotes? Who knows the suppliers? What happened the last time you took a long vacation? Buyers and their lenders will ask these questions, and the answers tell them how hard the handover will be.

Reducing owner dependence takes time, because the evidence that matters is a track record. Promising that a manager could run things is weak. Showing a year of results while a manager actually did run things is strong.

• Name a second in command and give them real authority over daily operations, hiring and scheduling.
• Move your personal customer relationships to an account manager, and introduce them to the customers well before any sale.
• Write down how quotes, pricing, purchasing and quality checks are done, so the knowledge isn't only in your head.
• Check whether any license, permit, certification or supplier agreement is in your personal name, and ask your attorney what it takes to transfer or replace it.
• Take time away from the business and keep a record of how it ran without you.

Recurring revenue: earnings a buyer can count on

Revenue that repeats on a schedule is easier to value than revenue you have to win again every month. A buyer looking at service contracts, maintenance agreements, subscriptions or a loyal base of reorders can see next year's starting point. That certainty is what supports a higher multiple, and it is also what a lender likes to see when it underwrites a buyer.

Not all repeat revenue counts the same. A signed agreement with a renewal date is stronger than a customer who has simply bought for years. Automatic renewals are stronger than ones you have to resell. Revenue that is spread across many small recurring accounts is stronger than one large contract.

If your business is project-based, you don't need to become a subscription company. Look for the natural recurring piece: an annual inspection, a maintenance plan after an installation, a retainer for ongoing support, a supply agreement with a regular customer. Then track it separately so a buyer can see it grow.

• Report recurring and one-time revenue separately in your monthly financials.
• Track how many customers renew each year and how long the average customer stays.
• Put informal repeat arrangements on paper, with terms that survive a change of ownership.

Customer concentration: when one account carries the business

If a single customer, or a handful, provides much of your profit, a buyer is really buying that relationship. Losing it after closing would hurt the business badly, and the sale itself can be the trigger: the customer's contact may have been loyal to you, or the customer may use the change of ownership to renegotiate.

Buyers respond to concentration in predictable ways. They ask to speak with the big customer before closing. They ask whether the contract can be assigned to a new owner. They may lower the multiple, or keep the price but make part of it depend on that customer staying, through an earn-out or a seller note that can be reduced if revenue falls.

There is no shortcut here. The fixes are to grow the rest of the customer base, extend and strengthen the large contracts, and make sure more than one person at your company has a relationship with each big account.

Growth trend: the direction matters as much as the level

Buyers look at several years of results, not just the latest one. A steady or rising trend supports the earnings figure and gives the buyer confidence in the multiple. A falling trend does the opposite, and it invites the buyer to price off the weakest recent period rather than the average.

The trend also has to hold up during the sale. Diligence takes months, and buyers watch your monthly results the whole time. If revenue or margins slip because you are distracted by the deal, expect the buyer to ask to revisit the price. Planning for the time a sale takes is part of protecting your value.

Be careful with projections. Buyers will listen to a credible growth plan, especially one backed by a pipeline, a backlog or signed contracts, but they rarely pay in full for growth that hasn't happened yet. When they do, it is often through an earn-out that pays only if the growth arrives.

Clean books and records: protecting the earnings figure

Clean records don't usually raise the multiple on their own, but messy records reliably lower the earnings figure. The SBA tells buyers to have an attorney and an accountant review a seller's financial statements, tax returns, contracts and leases, and to check that licenses and permits will transfer [2]. Anything those advisors can't verify, they will discount or ask you to guarantee.

Add-backs are where most of the money is. Owners rightly add back their own pay above a market salary, personal expenses run through the business, and true one-time costs. Buyers accept add-backs they can prove and reject the rest, and each rejected add-back reduces the price by that amount times the multiple.

Records go beyond the profit and loss statement. Buyers will also want your balance sheet, payroll records, customer contracts, your lease and whether it can be assigned, equipment lists, insurance, and any permits or licenses the business needs to operate. Gathering these before a buyer asks saves time and avoids the impression that something is hidden.

• Make sure your financial statements tie to your tax returns and your bank deposits.
• Keep a written add-back schedule with the invoice, payroll record or bill that supports each item.
• Stop running personal expenses through the business well before a sale, so fewer adjustments are needed at all.
• Collect your key contracts, lease, permits and insurance policies in one place.

Size: what our data shows by earnings band

Size is the one value driver our comps dataset can speak to directly, because it reports median multiples by sector and size band [6]. To keep the comparison like for like, the table below compares only the two smallest SDE bands, which use the same earnings measure: the under $500K SDE band and the $500K to $1M SDE band [6]. A sector appears only if both of its cells are published, meaning each has enough closed sales to report a median.

In 6 of 10 sectors with published cells in both bands, the median multiple was higher in the $500K to $1M SDE band [6]. In the others, it was the same in 1 sector, and it was lower in 3 sectors [6]. So size tends to help, but it is not a guarantee. A bigger business in a weak sector, or one with the problems described on this page, can still sell for a lower multiple than a smaller, cleaner one.

We don't compare an SDE band with an EBITDA band here. SDE includes the owner's pay and EBITDA doesn't, so the two multiples aren't on the same footing. SDE vs EBITDA explains the difference, and is my business big enough for private equity? covers what changes when you cross into the larger, EBITDA-priced bands.

Why might size help? A larger business usually has more customers, more staff and a management layer, so less of its profit depends on any one person or account. It can also be bought by more kinds of buyers, and more qualified buyers means more competition. But those are reasons size tends to correlate with the other factors on this page, not a separate reward for being big.

Things that don't raise value as much as owners hope

Some changes feel like they should make a business worth more, and buyers mostly look past them. Knowing which ones saves you effort in the run-up to a sale.

• Revenue without profit. Buyers price earnings, not sales. Growing revenue by cutting prices or taking on low-margin work can leave the earnings figure flat or lower, and a bigger top line with the same profit rarely moves the price.
• Unsupported add-backs. A long list of adjustments that you can't document doesn't raise the earnings figure, because the buyer will strip most of them out. It can also make a buyer doubt the rest of your numbers.
• One big year. A single strong year, from a one-off contract, a price spike or a lucky season, is often treated as an outlier. Buyers tend to average it with the years around it or ask why it won't repeat.
• Recent large purchases. New equipment, a renovation or a new vehicle fleet just before a sale may be needed, but buyers usually don't pay you back for it dollar for dollar. It is part of what it takes to produce the earnings they are already paying for.
• Plans you haven't started. A new product line or territory you intend to open is worth little to a buyer until it produces results. If you want credit for it, expect an earn-out.
• Your personal effort. Long hours that hold the business together can make owner dependence worse, not better, unless the work is handed to people who will stay.

Value killers buyers find in diligence

Diligence is where a buyer checks everything it was told. Problems found here are expensive, because the buyer has already agreed a price and now has a reason to change it. The common ones:

• Financial statements that don't tie to tax returns or bank deposits, or revenue that can't be traced.
• Undisclosed liabilities: unpaid taxes, misclassified workers, warranty claims, or debts that weren't on the balance sheet.
• Pending or threatened litigation, or regulatory problems you hadn't mentioned.
• A lease that can't be assigned, or a landlord who won't agree terms with the new owner.
• Licenses, permits or certifications that don't transfer, or that are held by someone who is leaving.
• Key customers or employees who signal they will leave after the sale.
• Results that dip during the deal, which hands the buyer a reason to renegotiate.

How value drivers shift the deal terms, not just the price

Value drivers don't only change the headline number. They change how the price is paid. A buyer who is confident in your earnings will pay more of the price in cash at closing. A buyer who sees risk it can't measure will try to share that risk with you.

The two most common tools are earn-outs and seller notes. An earn-out makes part of the price depend on the business hitting targets after closing, which shifts growth and customer risk back onto you. A seller note means you lend the buyer part of the price and are repaid over time, so you stay exposed to how the business does under its new owner. See earn-outs and seller notes for how each works and what to negotiate.

Financing matters too. Many buyers of smaller businesses borrow through the SBA's 7(a) program, which can fund changes of ownership [3]. The lender underwrites your business as well as the buyer, so clean records and a steady trend make the loan easier to approve. If you take part of the price over time, the IRS generally treats it as an installment sale, meaning at least one payment arrives after the tax year of the sale, reported on Form 6252 [4]. Talk to your CPA about how structure changes your tax, and see taxes when selling a business.

A short plan for the year or two before a sale

Most of these factors take time to change, and buyers want to see the change in your results, not just hear about it. In rough order of when to start:

1. Get your books in order first. Engage a CPA, tie your statements to your tax returns, and start an add-back schedule with evidence.
2. Start reducing owner dependence. Name a second in command and begin handing over customer relationships and daily decisions.
3. Work on revenue quality. Put repeat customers on agreements, add recurring services where they fit, and widen the customer base.
4. Protect the trend. Keep investing in growth and avoid one-off moves that make the latest year look unusual.
5. Clean up the legal side. Review leases, contracts, permits and licenses with your attorney, and fix anything that won't transfer.
6. Know your number. Check your sector and size band in the multiples index, and run your earnings through the value range calculator.

How this guide fits with the others

This guide is about what changes the price and what you can do about it. If you want the buyer's side of the same picture, including the checklist buyers score and how individual buyers, search funds, private equity and strategic acquirers weigh it differently, read what buyers look for in a business.

For timing, and the full checklist for getting a business ready over two years, see when to sell your business. For the full sale process, see how to sell a business, and for what the buyer will examine before closing, business sale due diligence.

If you are deciding who should help you sell, compare options in should I use a business broker? and how to choose an M&A advisor, or read selling a business without a broker if a buyer has already approached you. To keep the process quiet while you prepare, see how to sell a business confidentially.

Where Axia fits, and what it does not do

Axia Growth works on the buyer side. Buyers such as private equity firms, search funds, strategic acquirers and holding companies set acquisition criteria and engage Axia to find privately held companies that fit. Axia calls those owners and introduces the interested ones to the buyer. The buyer pays Axia. Owners pay Axia nothing, whether or not they sell [5].

Axia publishes the multiples data on this page so owners can check their own numbers, but Axia is not on your side of the table. It does not represent sellers, value businesses, negotiate terms, structure deals, or take part in due diligence or closing, and it holds no business-broker, real estate or securities license [5]. For a formal opinion of value, the SBA suggests consulting valuation experts along with lawyers and accountants [1]. See who pays and how it works for owners.