On the surface, business acquisitions can feel like a battle: sellers want top dollar for their businesses, and buyers want a steal of a deal.

Believe it or not, when a deal is done right, it doesn’t need to be a fight at all. Both sides can win, walking away with exactly what they want.

Curious how? Let’s break it down.

When I recently participated in a panel with several successful business owners sharing stories of various exits we made throughout the years, a number of business owners had impressive accomplishments, exiting their businesses for $100 million (and up).

That said, while high-profile exits are inspiring, the majority of business transactions – about 99.6% – involve companies earning less than $5 million in revenue. While big exits get a lot of attention, the vast majority of buyers and sellers, probably including you, are dealing with transactions in the $1 to $6 million range, or even up to $25 million.

Because drivers of value change depending on the tier of the market, today we’re going to be addressing this specific segment. This is the market most of you reading are interested in, so everything we’ll discuss here applies specifically to that.

Today, I’ll discuss the main factors that drive business value and what you can do as a buyer or seller to maximize your interests within this deal range.

 

What Drives Business Value?

Let me talk to sellers for a moment.

For sellers, it’s important to first understand the fundamental drivers of value, which are growth and earnings. Growth rate and earnings (whether it’s seller’s discretionary earnings or EBITDA) are directly correlated to the valuation of your company, and, in turn, how much you’ll be able to sell your business for.

The rate of growth determines how your business is trending: is it growing, stable, or declining? For reference, when people describe a business as “flat,” it often subtly means it’s slightly declining.

Ultimately, though, earnings determine which valuation “ballpark” your business falls into.

These are valuation ranges that attract different types of buyers and varying levels of capital. For instance, a company with $100,000 in earnings will appeal to a different buyer pool and command a different price range than one with $500,000 or $1 million in earnings, and vastly different from companies with earnings of $50 million or more.

Simply put, the size of your earnings largely determines your valuation range.

 

Source: MidStreet

 

Growth rate, on the other hand, drives the valuation multiple within that ballpark. 

If a business has earnings of, say, $500,000 but is trending down, it will struggle to attract buyers willing to pay a higher multiple for the company. For example, if the valuation range is anywhere from 2 to 4X the SDE, a buyer would be reluctant to pay a 4X multiple for a business that has a flat or negative growth rate.

It’s simple buyer psychology.

Most buyers avoid companies that are “falling knives” – where the business is visibly declining with no clear path to recovery. While some people quote Baron Rothschild’s advice to “buy when there’s blood in the streets,” the reality is that if a business is in a state of freefall, most buyers will hesitate. If they do buy, it’s usually with high anxiety and low expectations.

With businesses that are declining, there’s no guarantee that it will experience a recovery in the way you might expect with the macroeconomic market, and buyers assume, rightfully so, that a business on the decline is performing poorly due to its inherent lack of value.

Earnings will determine a valuation range and growth maximizes the multiple on earnings in your particular ballpark. 

A quick side note on growth: if your business isn’t growing at 20% annually through organic means or innovations, consider exploring a growth-through-acquisition strategy.

Some of the most valuable companies in the U.S. consistently achieve 20% growth over at least five years, starting from $1 million in revenue. These highly valuable companies aren’t always large corporations; they’re often smaller businesses that operate under the radar yet drive economic growth.

 

Key Value Drivers for Sellers

Although professionals may argue that there is a much longer list of factors that maximize a business’s transaction values, if you’re a business owner looking to sell your business, these are the four key areas you should pay attention to in addition to growth and earnings:

 

1. Risk Mitigation

Business risks are critical factors that buyers evaluate to determine a company’s value, and they will pay more for businesses with lower inherent risk. Higher risks generally mean a lower valuation, as buyers may see the acquisition as less secure, but offsetting these risks can make your business look more attractive to buyers.

For example, buyers are willing to pay more for companies that don’t rely heavily on a single customer, channel, or product, as these diversifications reduce inherent risks.

 

We’ve covered risk at length here, but to recap, here are some of the top risks to pay attention to and mitigate:

• Financial Stability: Strong profitability and recurring revenue provide a buffer during the transfer.
• Low Concentration: Diversified products and suppliers prevent reliance on single points of failure.
• Staff Organization: Evaluate if the current team’s size and skills align with the business’s needs to minimize risks.
• Deal Structuring: Smart deal terms, like seller financing or earn-outs, ensure affordability and early cash flow.

 

2. Clean Documentation

Next, let’s talk about documentation. Clear documentation signals transparency and reliability, instilling confidence in buyers. This documentation can include standard operating procedures (SOPs) and accurate financial records.

SOPs allow for easy transfer of responsibilities, making it possible to replace employees or handle tasks efficiently. Additionally, clean financial documentation is crucial – internal financial statements should align with tax returns, and there should be no co-mingling with other businesses.

 

Source: Investopedia

 

Overall, sellers should ensure that all financial and operational aspects are documented – if something isn’t documented, buyers may (and should) assume it doesn’t exist.

One time in the Lab, one of our buyers approached me about a seller claiming to earn $150,000 in cash. While this was likely true, it wasn’t documented.

My advice? If it isn’t documented, it doesn’t count. 

As a buyer, it’s unwise to pay a premium for undocumented earnings, as they haven’t been taxed and carry significant risk. In acquisitions, “trust but verify” is key – if it’s not documented, it’s better not to rely on it.

 

3. Transferability

Moving on to transferability.

Transferability is the ease in which a business transitions from the seller to the buyer. Think of it like a turnkey house versus one that’s a gut job. One requires no work to operate at all, and the other has a lot of work you’ll need to do to make it livable.

The easier a business can transfer from the seller to the buyer, the more valuable it is. 

One way to increase transferability is by hiring someone to take over tasks you’ve been handling yourself.

Although it might seem counterintuitive to raise operating expenses (and lower profitability) by creating a seemingly unnecessary position, doing so can help you transfer the business with ease and increase the value of the business

 

Source: Grow and Sell Your Business – Slideshare

 

To do this, you can gradually reduce your involvement, ideally working fewer than 20 hours a week. While this might reduce growth in the short term, it makes the business more attractive because it demonstrates that it can function independently, similar to a turnkey house.

A business that doesn’t rely heavily on the owner’s specialized knowledge is far easier to sell.

For example, if a radiologist owns a practice and is the sole person interpreting charts and diagnosing, the business is hard to transfer unless sold to another radiologist. Buyers will discount businesses that rely on specialized, non-transferable expertise because the earnings aren’t sustainable without the seller.

Creating a business that’s transferable adds value and widens the pool of potential buyers, making it a critical aspect to consider for any exit plan.

 

4. Growth Opportunities

Lastly, let’s consider growth opportunities. Here, we’re not talking about historical growth but rather the potential for future expansion. Growth opportunities address whether there’s still “meat on the bone” or if the company has peaked and is leveling off.

 

Source: FasterCapital

 

Often, sellers are ready to move on because their company’s growth rate has slowed.

For instance, a business might have once grown 100% year over year, then 75%, then 50%, and now it’s down to 18%. This slowing trend signals the seller may have taken the business as far as they can, making it an ideal time for buyers to step in and capitalize on untapped potential.

This is what buyers are looking for: potential beyond current earnings.

 

Seller Motivations & Seller Timing

When it comes to considering the risk profile and growth opportunities of a business, you might find yourself wondering at some point: Is the seller hiding something?

It’s easy to go down this rabbit hole of suspicion, but I caution you to not get too caught up in why the seller is exiting.

While it’s common to be curious, like when someone sells a house because they’re downsizing or relocating, the reason usually doesn’t impact the asset’s intrinsic value. Similarly, in business, a seller’s motivation may be as simple as wanting to move on, and you can typically see this in the numbers.

If you think about it, the timing of sellers wanting to exit actually works incredibly well for buyers. A buyer is ready to infuse a business with much needed fresh energy and perspective, just as the business is starting to decline and a seller is tapped out.

By leveraging low capital upfront and by building equity, you can reinvigorate the business and drive it to new growth. This growth opportunity – combined with timing, leverage, and the business’s intrinsic value – creates a powerful foundation for successful business acquisition.

 

But What About XYZ? How Other Assets Are Factored Into Valuation

During a talk last week, an entrepreneur asked about my views on hiring top talent and how it impacts business value. This is a variation of a pretty common question I get from sellers.

Essentially, he asked:

You emphasize growth, earnings, transferability, and documentation, but what about the investment I’ve made in building a great team?

This entrepreneur had been strategically investing in top talent to create a dynamic culture and leverage the competitive advantage that comes from having a strong team, which is an excellent long-term approach to building a sustainable company.

However, while a skilled team is valuable, or any other type of asset for that matter, the core components that drive business valuation remain the same. It doesn’t matter if you have the best talent, a fleet of trucks, or unique machinery – valuation is ultimately based on measurable growth, earnings, and transferability.

When you’re managing a business, you make strategic decisions to grow the company and increase earnings. Investing in top talent is one way to achieve this; a skilled team can drive exceptional growth and boost earnings, which will reflect positively in the business’s valuation:

 

Source: Gallup via Corporate Rebels

 

Hiring the best people may come with a higher cost, but it often results in a powerhouse company, increasing the overall value of the business.

My point is: even if other assets or sources of value (employees, large social media following, celebrity endorsement, etc.) are not directly considered when it comes to valuation, the growth and earnings these assets facilitate are.

In the end, as a seller, focus on the fundamentals – growth, earnings, transferability, and risk management – while leveraging your team to minimize your workload and drive these metrics forward.

 

Key Considerations for Buyers & Sellers

Buyers, remember: we’re all looking to pay a premium for businesses that demonstrate certain strengths. However, if a business shows declining year-over-year performance, low earnings, narrow profit margins, or lacks growth opportunities, it’s not a good buy.

If a business can’t be transferred because critical knowledge is locked in the owner’s head or a key person is leaving, that’s a major red flag. Similarly, poor documentation – like sloppy books, commingled finances, or missing records – is a deterrent. Add in risks like dependence on a single sales channel or one customer making up 70% of revenue, and this business is not only low-value but may even be unsellable.

Use these metrics as your levers when evaluating offers and assessing potential acquisitions. Solid fundamentals in these areas will ensure you’re making a smart investment and help you confidently navigate the buying process.

For sellers, even if you’re struggling in some of these areas, you can still adjust course to align your business goals with a strategic sale. Exit planning is about tightening up these critical areas to create a more appealing package.

Ask yourself these questions: Is the business growth sustainable? Is it properly documented? Is it transferable? These are elements you can control and improve, whether you’re years out from selling or considering selling in one year.

Ready to acquire a business in the next 12 months? The Acquisition Lab is your first stop. Reach out to us today and get on the fast track to becoming an acquisition entrepreneur.