How a buyer values a small service business
Profit, owner wages, add-backs, risk and why two similar businesses can sell for very different prices.
By Owners often hear a rule of thumb from a mate at the pub and anchor to it. The reality is that most small service businesses are valued on what they reliably earn for a new owner, adjusted for how risky those earnings look. Understanding the logic helps you have a calmer conversation about price, whoever you end up talking to.
Start with what the business really earns
A buyer will usually start with your profit and then adjust it. Personal expenses run through the business, one-off costs and unusually high or low owner wages are the common adjustments.
These are often called add-backs or normalisations.
Every add-back needs evidence. A buyer will accept a clearly documented one-off cost far more readily than a vague claim that some expenses were personal.
Account for the owner's own work
If you work sixty hours a week in the business, a buyer has to either do that work themselves or pay someone to do it. A fair valuation deducts a realistic wage for the roles you fill.
This is one reason businesses that rely heavily on the owner are valued lower. It is not a judgement of the owner.
It reflects the cost and risk of replacing them.
Apply a multiple that reflects risk
The adjusted earnings are then multiplied by a figure that reflects risk and growth. Recurring contracts, a spread of customers, a capable team, good systems and a long lease push the multiple up.
Customer concentration, owner dependence, key staff risk and ageing equipment push it down.
That is why two businesses with the same profit can sell for very different prices. The multiple is really a buyer's view of how confident they can be that the earnings will continue.
Remember what's included
Agree early whether the price includes plant and equipment, vehicles, stock and working capital. Stock is often valued separately at completion.
Debtors and creditors are often kept by the seller.
Clarify these items early, or two parties who think they agree on a price can discover they were talking about different things.
Get an independent view
A buyer's number is the buyer's number. Before you respond to any offer, ask your accountant or an independent valuer for a view.
A range with reasons is more useful than a single figure.
If you are talking to me, I'll explain how I've reached any number and what assumptions sit behind it, so your adviser can test it properly.
Your checklist
What to do next
- List every add-back with evidence
- Estimate the cost of replacing your own roles
- Note what makes your earnings more or less certain
- Agree what the price includes and excludes
- Ask for the buyer's assumptions in writing
- Get an independent view before responding
Example
Two HVAC businesses each make similar adjusted profit. One has maintenance contracts across 200 commercial sites and a supervisor who runs the crews. The other relies on one builder for most of its work and the owner quotes every job. A buyer would reasonably pay more for the first, because its earnings are more likely to continue after the sale.
An illustrative example, not a real client or transaction.
Questions owners ask
Is there a standard multiple for my industry?+
There are rough ranges, but they vary widely with size, risk and structure. Treat any single number with caution and get advice.
Should I spend money improving the business before I sell?+
Only where it also makes sense for running the business. Documenting processes and reducing owner dependence usually help more than cosmetic changes.
Do you pay for goodwill?+
Goodwill is part of most valuations. It reflects the value of the earnings over and above the physical assets.
Important
This article is general information only. It doesn't take your personal circumstances into account and isn't financial, legal, tax, employment or valuation advice. Velaro Group is a buyer of businesses. It isn't a business broker, licensed financial adviser, registered tax agent or law firm, and it doesn't act for sellers. Please get advice from your own accountant, solicitor or financial adviser before making any decision. Read the full disclaimer.
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