What is my business worth, and why is revenue not the answer?

When an owner first thinks about selling, the same question almost always comes up: “Our revenue is this much. What might the business be worth?” The answer is disappointing but important: revenue alone cannot tell you a business's value. Two companies with the same revenue can differ threefold in value.

What a buyer is really buying

A buyer is buying future income, not the past. Specifically, the income the business can generate without you . That is why the starting point is normalised earnings, rather than revenue.

What is normalised EBITDA?

EBITDA means earnings before interest, tax, depreciation and amortisation. “Normalised” means adjusting for one-off items and items specific to the owner. Typical examples include:

• An owner's remuneration above or below market rates.
• Company cars, phones and travel that are actually used for personal purposes.
• One-off income and costs: litigation, a grant or a large compensation payment.
• Rent or upkeep of property not used for business purposes.

This adjusted figure is what the buyer uses to build a price. It is also what most businesses need to put in order first, because their accounts are prepared for tax purposes rather than for a sale.

The multiple and what drives it

Valuation using an earnings multiple starts with normalised earnings. The appropriate multiple must be assessed using the business's characteristics and comparable transactions. In specialist markets, a general multiple is particularly limited on its own. The following factors are among those that matter.

1. Reliance on the owner

This is the largest single factor. If the business would stop within two months without you, the buyer is buying a job rather than a business. If there is a capable management team that knows the customers and can keep operations going, the multiple rises materially.

2. Customer concentration

If more than a third of revenue comes from one customer, the buyer prices in that risk, because the contract could be terminated after the transaction. A diversified customer base is always worth more.

3. The share of recurring revenue

Contracted, predictable revenue is worth more than the same amount of project-based revenue. Maintenance contracts, subscriptions and framework agreements should be shown separately.

4. The quality of financial records

This is the quickest factor to improve. If the accounts are clear, contracts organised, stock counted and asset records accurate, due diligence can be fast and smooth. The buyer sees lower risk, which is reflected in the price.

What the multiple does not include

The value derived from a multiple prices the business operations. Net cash, non-operating property and, in some cases, stock are accounted for in addition to, or within, that figure. The exact treatment depends on the deal structure and varies from transaction to transaction. That is why an online calculator with three questions cannot give a meaningful answer.

Specialist sectors are a separate case

In a specialist sector, comparable transactions are scarce, so the multiple approach is only a starting point. The price often depends on how much entering that market is worth to a particular buyer: how much time and money they save by buying your business instead of building the same thing from scratch. A good adviser's task here is not simply to calculate an “objective value”, but to find the buyer to whom your business is worth the most.

Business value, asking price and purchase price

These are three different figures, and it is worth keeping them distinct. The business value is the professional estimate. The asking price is the figure we take to market, which also allows room for negotiation. The purchase price is the figure in the contract, reflecting due diligence findings and payment terms. A good process brings these three figures close together.