Insights

What a business is worth to an owner and what a buyer will pay are often two different things. The gap comes down to a handful of factors business owners should understand before they’re in the process.

When owners ask what their business is worth, they usually want one number. Is it $5 million? $10 million? $15 million? Most are not thinking about deal terms yet, or taxes. They just want to know the ballpark.

That is a reasonable starting point. But what a business is worth to an owner and what a buyer will pay can be two different things. There have been times we have told owners they should not sell yet because the value of the business to them personally is higher than what the market would likely pay. But when someone is ready to retire, they are ready.

Where Value Starts

In the lower middle market, value usually starts with earnings. The larger the EBITDA, the higher the multiple tends to be. Two companies can look similar on the surface, but if one earns $4 million a year and another earns $1 million, the larger one will usually sell at a higher multiple. Buyers view it as less risky. That pattern holds up consistently in the data.

But EBITDA alone does not tell the whole story.

The Three Factors That Drive the Gap

The first thing buyers look at is the financial trend. Is revenue and income going up, holding steady, or going down? Steady or growing is fine. Declining for two or three years is a problem. Owners will often say they have been in business for 30 years and it goes up and down. That may be true. But buyers are looking at what has happened recently and what it suggests about next year. If earnings have been down for three years, buyers want to understand why and whether it is going to continue.

The second major factor is customer concentration. This is probably the issue we run into most often in the lower middle market. If one customer accounts for 50 or 60 percent of revenue, buyers see that as real risk. The business may still be saleable, but the terms will usually reflect it. Value comes down, or the deal gets structured in a way that shifts risk back to the seller.

Customer concentration is also one of the hardest things to fix before going to market. Diversifying takes time — often years — and owners who are burned out and ready to retire are not going to go out and rebuild their customer base. We end up having to find the right buyer for those situations rather than solving the problem first.

The third factor is management depth. Buyers pay attention to whether the business can run without the owner. If the owner handles all the key relationships, makes most of the pricing decisions, and holds most of the operational knowledge, that creates transition risk. A business with a capable team already in place — one that keeps running after the owner leaves — is going to be worth more and attract more buyers.

These three things — trend, customer concentration, and management — explain most of the variation we see when two businesses with similar earnings sell for very different prices.

Why Margins Matter More Than Revenue

There is one other thing worth noting. Margins matter, not just revenue. We have seen two businesses that both generate $2 million in EBITDA. One has $15 million in sales and the other has $100 million. The smaller company is far more profitable. The larger one is churning a lot of revenue to produce the same result. Buyers notice that. The best owners focus on profit and margins, not top-line revenue. Top-line revenue does not help as much when it comes time to sell.

What Buyers Are Really Underwriting

What buyers are really underwriting is the durability of profit. Will customers stay? Will key employees stay after the owner leaves? Are there relationships or knowledge tied to the owner that will walk out the door with them? Are there problems in the financials or risks in the business that could cause earnings to decline after closing?

Those questions often explain why a formal valuation report and actual buyer offers do not always match. Valuation reports generally follow a standard process. They are mostly mathematical and mostly backward-looking. Buyers dig in deeper. They evaluate the qualitative things — customers, trends, management, transferability, intellectual property — that can significantly move what they are willing to pay.

Deal Structure Changes the Math

Deal structure also matters more than owners usually expect going in.

An all-cash offer at a lower number can be worth more than a higher offer that depends on an earnout. If the earnout requires growth the business has never demonstrated, there is a real chance the seller never sees that money. How the deal is structured also affects what the seller keeps after taxes — something that comes into play with purchase price allocation. Seller notes and rollover equity shift risk back to the seller in similar ways. When you adjust for that risk, the total price and the actual value of the deal can look very different.

Timing Can Move the Number

Timing can also make a meaningful difference.

We once advised an owner to wait before going to market. Several positive things were happening in the business but had not yet shown up in the financial statements. We suggested waiting six to twelve months for those improvements to be reflected in the numbers. The owner agreed, and by the time the business sold, the value had gone from around $4 million to roughly $11 million. That is an extreme example, but the principle applies more often than people realize. When possible, patience can make a difference.

Don’t Let Fatigue Destroy Value

We have also seen the opposite happen. Owners get tired and start making decisions that quietly reduce the value of their business just before they plan to sell.

One owner let an entire commercial sales channel disappear because the manager left and he did not want to go through the process of hiring a replacement. Another eliminated a profitable product line because it was bulky and inconvenient to handle. In another situation, an owner dropped a long-standing customer in the middle of the sale process because he was tired of dealing with them — with about two months left before closing. In each case there may have been understandable reasons. But the timing hurt the value of the business. Don’t let fatigue destroy value.

If You Plan to Sell in the Next One to Three Years

For owners who are thinking about selling in the next one to three years, the focus should be on the fundamentals. Build a team that can run the business without you. Reduce customer concentration where you can. Address any legal or environmental issues before you go to market. If the financial trend has weakened, work on stabilizing it before you start the process.

The Bottom Line

Longevity alone rarely drives value. We have had owners come to us who have been in business for 30 or 40 years and assume that counts for something. It can, but only if it shows up in the numbers. Buyers pay for profit and they discount for risk. The more risk they see, the less they are willing to pay.

Value is not a fixed number waiting to be discovered. It is built, or quietly eroded, by the decisions an owner makes in the years before a sale. The businesses that sell at the strongest multiples are not always the biggest or the oldest. They are the ones where buyers see durable earnings, limited risk, and an operation that can continue without its founder. Understanding what actually drives value, and working on it deliberately, is the most important thing an owner can do before starting the process.

BMI Mergers & Acquisitions is a lower middle market M&A advisory firm representing business owners in confidential, value-maximizing transactions. Our advisors have over 40 combined years of experience across manufacturing, distribution, technology, healthcare, and business services.