So what’s behind the seller’s earnings curtain?
When it’s time to consider selling your business, valuation will often be at the front of your mind. After years of hard work, dedication, and building a strong enterprise, it’s finally time for a well-earned paycheck! Naturally, you want to be compensated as much as possible for the value you’ve created.
However, determining a business’s worth is not as simple as looking at annual revenue or net income. Valuation can often feel like a moving target, influenced by various factors such as market demand, financial performance, and industry trends. Sellers want to maximize their sale price, while buyers are looking to negotiate the best possible deal—often pushing the price lower than the seller’s expectations.
Understanding Business Valuation: Seller vs. Buyer Perspectives
At its core, the value of a business—like most other assets—is based on the price that a buyer and seller agree upon in a fair and open market. This means both parties evaluate the transaction differently:
- Sellers exchange their future earnings for an immediate payment, ideally securing a price that reflects their years of effort and investment.
- Buyers see the purchase as a long-term investment, assessing whether the expected ROI (Return on Investment) makes the risk and cost worthwhile.
While sales figures and net income provide useful reference points, they alone are not enough to determine a proper valuation. There are deeper financial metrics at play.
Seller’s Discretionary Earnings (SDE): A Key Valuation Metric
The most critical number buyers and lenders look at when assessing a business for sale is Seller’s Discretionary Earnings (SDE).
SDE is not just the tax return net income but rather a figure adjusted for various components, such as:
- Owner’s salary and benefits (compensation that may not be required for a new owner).
- Non-business expenses (items listed in the net income that aren’t necessary for operations).
- One-time costs (such as legal fees, renovations, or other non-recurring expenses).
Once SDE is determined, valuation experts apply an industry multiple to compare the business with similar ones that have been listed or sold. The multiple depends on factors like:
- Size and revenue levels—larger businesses often command higher multiples.
- Company assets—physical equipment, inventory, and intellectual property can enhance value.
- Financial trends—steady revenue and profitability growth strengthen the valuation.
Understanding Owner’s Earnings: A Deeper Look at Cash Flow
Another important factor in assessing a business’s true financial health is Owner’s Earnings—a concept often used by investors and financial analysts when determining a company’s long-term cash flow potential.
Owner’s Earnings represent the actual cash that a business generates for the owner after accounting for essential expenses. Unlike SDE, which focuses on adjusted earnings for valuation purposes, Owner’s Earnings provide insight into the true profitability and cash flow stability of a business.
The formula for calculating Owner’s Earnings typically involves:
- Net Income – the company’s earnings after expenses.
- Non-Cash Expenses – adding back depreciation and amortization.
- Changes in Working Capital – adjusting for fluctuations in receivables, payables, and inventory.
- Capital Expenditures – deducting necessary reinvestments to maintain operations.
Why does Owner’s Earnings matter in a sale?
- It reveals how much cash the buyer can realistically expect to generate after taking over the business.
- Buyers seeking financial stability prioritize businesses with strong owner’s earnings, as it indicates predictable returns.
- It helps sellers position their business as a sound investment, especially when highlighting consistent cash flow over time.
The Subjectivity of Valuation: More Than Just Numbers
While metrics like SDE and Owner’s Earnings provide financial benchmarks, there is always an element of subjectivity in valuation. External factors such as brand strength, customer loyalty, and industry health influence perceived worth beyond just financial statements.
A well-positioned business is one that:
- Has efficient operations, making it appealing for buyers.
- Demonstrates revenue stability, ensuring profitability for the new owner.
- Offers growth potential, making it an attractive long-term investment.
Closing Thoughts
Ultimately, the sale of a business requires careful evaluation of earnings, market conditions, and growth potential. A seasoned business broker understands that valuation is both an art and a science, balancing objective financial metrics with intangible business assets.
For sellers, maximizing their payout requires financial preparation, operational efficiency, and strategic positioning—ensuring buyers recognize the true value of the business.
Would you like additional insights on negotiation tactics or ways to enhance business valuation before selling? I’d be happy to refine this further based on your goals
See what sort of seller’s earnings “multiples” other businesses are getting, with our internal business MLS search engine:
Search Listings – TC Business Brokers & Commercial
Read more about business valuations and value, from the SBA:
Merge and acquire businesses | U.S. Small Business Administration