A valuation gives you a disciplined basis for that assessment. It does not produce a single unquestionable price, because value depends on the quality of earnings, assets, risk and future ownership requirements. A small owner-operated business may be assessed using seller’s discretionary earnings, or SDE, which can add back the owner’s salary and certain personal expenses. A larger operation may be considered through EBITDA, or earnings before interest, tax, depreciation and amortisation. If you plan to buy a business, ask which measure has been used, what adjustments were made and whether the result assumes you will replace the owner’s daily labour.
Reported profit is only a starting point. Normalising the accounts means adjusting them to reflect the costs and income a typical future owner is likely to face. A related company may have charged below-market rent, or a family member may have worked unpaid in the office. Those items can reduce the apparent earnings once corrected. Ask for several years of financial statements, tax returns, management accounts and bank deposit records. A practical habit is to reconcile the sales shown in the profit and loss statement with deposits and point-of-sale reports before discussing a multiple. Also examine monthly gross margins, wage costs and customer sales rather than relying on one strong recent quarter.
Settlement funds are not the same as operating funds. Working capital covers the period between paying suppliers, staff and other bills and receiving customer payments. A buyer who uses every available dollar for the purchase may be unable to replace a failed freezer, order materials or meet payroll during a slow month. Stock should be counted and valued separately, with obsolete, damaged and slow-moving items identified rather than accepted at full retail price. Equipment needs a physical inspection and, where relevant, service records or repair estimates. Book value is an accounting figure; current replacement cost and resale value may tell a very different story.
Due diligence should test each assumption behind the price. Review the largest customer accounts, sales by customer, supplier terms, recurring work, insurance policies, licences, complaints, threatened claims and employment records. Read the lease itself, including options, rent reviews, assignment provisions and any make-good obligations. Ask whether key customers have contracts or simply return because they know the owner. A business that receives half its revenue from one account carries a different risk from one with a broad customer base. Keep a written question register, record the document supporting each answer and mark unresolved matters before negotiations move forward.
Goodwill includes non-physical benefits such as repeat trade, reputation, systems and customer relationships. Its value may fall sharply if clients follow the departing owner or if staff do not know how work is won and delivered. Ask for a detailed handover plan covering introductions, passwords, supplier contacts, quoting methods, pending jobs and routine deadlines. Sit in on customer calls where appropriate, rather than accepting a general promise that introductions will occur later. Also confirm whether employees are willing to stay and whether their accrued entitlements, pay rates and duties have been correctly recorded. A non-compete clause may help, but its wording, scope and enforceability require legal review.
The transaction structure affects the risks you inherit. In an asset purchase, the parties generally identify the assets and liabilities that will transfer, while a share or entity purchase can leave the buyer with the company’s existing history and obligations. The suitable structure depends on legal, tax and commercial advice, not a simple preference for one form. Capital gains tax may affect the seller’s position and influence negotiations, but it does not determine the buyer’s result. A transfer within a family, an estate planning exercise or a proposed share transaction may require a valuation for a purpose different from setting a sale price. Ask each adviser to explain the assumptions in plain language.
Suppose a suburban service company is offered at four times adjusted annual earnings of $180,000. The headline price would be $720,000, but the calculation may omit replacement equipment, excess stock and the cost of hiring a manager after the owner leaves. If those items require $90,000 upfront and management costs $70,000 each year, the return available to the buyer changes substantially. Prepare conservative, expected and weak trading cases that include interest, tax, loan repayments, maintenance and the income you need personally. Seek valuation advice for buyers before treating a market multiple as proof that the asking price is fair.
A written offer should specify the assets included, the treatment of stock, retained debts, employee entitlements, deposits, work in progress and any excluded items. Include conditions for finance, satisfactory due diligence, landlord consent and the transfer of contracts, permits or licences where required. Set a clear process for verifying stock shortly before settlement and for adjusting the price if the count differs. Confirm who bears the risk of damage between signing and completion. Keep copies of source documents with the working valuation file, and do not rely on a verbal assurance that a matter will be fixed after settlement. The purchase should fit both the verified earnings and the practical demands of running the operation.
