Key Takeaways
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Many small businesses are assessed on maintainable earnings, with asset and market comparison methods used as cross-checks.
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No single multiple applies to every small business. The figure depends on the earnings measure, the risks and comparable sales.
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Earnings adjustments can increase or reduce reported profit, and each needs supporting records.
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Goodwill is the amount paid above the tangible assets, and buyers pay for it only where earnings can be verified and transferred.
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Lease security, owner dependence and the quality of the records explain much of the difference between businesses with similar profit.
The value of a small business depends on what it earns for its owner, how reliable those earnings are and what a qualified buyer is prepared to pay for them.
Understanding those factors explains why businesses with similar profit can sell for different prices, and why a free business appraisal looks beyond the profit and loss statement.
The Short Answer
A business is worth what a qualified buyer will pay for it on the open market. For an owner-operated business, buyers usually start with maintainable earnings, then consider the risks and comparable sales. The treatment of stock and equipment depends on the terms of the sale, and an appropriate range cannot be set from an industry label alone.
Main Valuation Methods
Brokers, valuers and buyers may rely on one or more of these approaches:
Earnings Multiple
This method is common for going-concern sales. Adjusted annual earnings are multiplied by a figure that reflects the risk profile of the business. State the earnings measure, because a multiple applied to seller’s discretionary earnings (SDE) is not the same as one applied to earnings before interest, tax, depreciation and amortisation (EBITDA).
Asset-Based Method
This approach looks at the market value of plant, equipment, fit-out and stock, less liabilities. It can be relevant for a business with little profit or one that is asset heavy, but it usually does not capture the value of a profitable business’s earnings.
Market Comparison
Comparable sales help test the results of other methods. Asking prices on listing portals are not sale prices, so this method depends on reliable information about completed transactions.
Discounted Cash Flow
Discounted cash flow (DCF) converts projected future cash flows to a present value using a rate that reflects risk. It is more common in formal valuations of larger businesses with predictable earnings than in small business sales, where buyers tend to rely on past results.
Adjusting the Profit
Accounts prepared for tax purposes may not show the ongoing earnings a new owner could expect. Normalisation adjusts reported profit to an ongoing basis, and adjustments can increase or reduce it.
Common Adjustments
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Owner’s salary and superannuation, where the earnings measure is SDE.
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Family labour paid above or below market rates, adjusted to a market cost either way.
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Depreciation and interest, where consistent with the earnings measure and without double counting.
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Genuine one-off costs, separated from ongoing maintenance and capital spending.
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Personal expenses run through the business.
What Buyers Will Question
A buyer’s accountant will test each adjustment. Recurring ‘one-off’ costs, marketing the business needs to keep trading, or an owner’s wage that understates the cost of replacing the owner are likely to be challenged. An unsupported adjustment can reduce trust in the rest of the figures.
Which Earnings Measure Applies
SDE adds back the owner’s wage, so it suits businesses the buyer will work in. EBITDA includes a market-rate manager’s wage in the costs, so it suits businesses that operate without the owner. Buyers may pay a different multiple for each, because the risks differ.
Industry Factors
Rather than relying on a published multiple, compare the factors buyers weigh in each sector:
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Hospitality: maintainable earnings, lease terms, owner dependence and completed sales of similar venues.
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Retail: repeat trade, stock quality, location, lease and reliance on the owner.
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Trade and service businesses: recurring contracts, staff and customer concentration.
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Professional services: whether clients are loyal to the firm or to an individual.
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Health and allied health: practitioner arrangements, billing records and regulatory requirements.
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Licensed businesses such as childcare: the licence, compliance history and the conditions attached to operating.
The appropriate multiple for any business depends on its own figures, lease and risks.
Understanding Goodwill
Goodwill is the amount paid above the value of the tangible assets. It reflects the earnings the business already produces through its customers, reputation, team, systems and location.
Buyers pay for goodwill only where the earnings can be verified and transferred. Unrecorded cash takings cannot be verified, and in premises-dependent businesses a short or uncertain lease can reduce goodwill significantly.
The contract usually allocates the price between goodwill, plant and equipment, and stock. The allocation can have tax consequences, so confirm it with your accountant before signing.
Same Profit, Different Price
Illustration only: two cafes each show the same adjusted earnings. The first depends on the owner working every shift, has a short lease without options and cannot verify part of its takings. The second has a manager in place, a longer lease with options, documented systems and records that reconcile to its BAS lodgements.
A buyer is likely to pay more for the second, because its earnings are more likely to continue after settlement. The actual prices would depend on comparable sales and each buyer’s own assessment.
Factors That Affect Value
Factors That Can Lift Value
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Earnings that do not depend on the owner, with a manager or senior staff member in place.
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A secure lease with options at a rent the trade supports.
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Financial records that reconcile to tax returns and BAS lodgements.
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Recurring revenue, such as memberships, contracts or retainers.
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Steady or growing sales over recent years.
Factors That Can Reduce Value
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Owner dependence, including key relationships held only by the owner.
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Declining sales or profit.
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A short lease, landlord dispute or redevelopment clause.
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Undocumented cash income or late accounts.
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Key staff likely to leave with the owner.
Appraisal or Formal Valuation
A broker’s appraisal is an opinion of the price a business is likely to achieve on the open market, based on buyer demand and comparable sales. A formal valuation is a documented report from a qualified valuer, typically used for tax, family law, partnership or other matters where an independent figure is required. Ask for a written quote, as the cost depends on the scope.
For an owner deciding whether and when to sell, an appraisal is usually the practical first step.
Start With Verified Earnings
Reconcile your records, document each earnings adjustment and review the lease before settling on a figure. Those are the areas a buyer’s accountant and solicitor will test first.
Bond Business Brokers can walk you through what the market is likely to pay for a business like yours.
Common Questions
Can offering vendor finance increase what my business sells for?
It may widen the pool of buyers able to fund a purchase, but it leaves the seller carrying risk until the balance is paid. Have a solicitor document the terms, security and default provisions.
How is the price allocated in the contract?
The contract usually splits the price between goodwill and plant and equipment, with stock often dealt with separately. Confirm the allocation with your accountant, as it can affect the tax outcome.
Does a short lease reduce what my business is worth?
It can, particularly for premises-dependent businesses, because a buyer needs time to recover the price. Discuss options or an extension with the landlord and your solicitor before listing.
This article provides general information only. Obtain advice from appropriately qualified advisers about your circumstances before entering into a transaction or relying on tax, legal or regulatory information.