Almost every lower and middle market transaction is priced the same way: a multiple applied to a normalised measure of earnings. The formula itself is trivial. Both of its inputs are contested, and the negotiation lives there rather than in the arithmetic.
Start with the earnings, not the multiple
Reported net income is not what a buyer pays for. It is the residue of tax planning, owner preference, and accounting policy. What a buyer underwrites is adjusted EBITDA: earnings before interest, taxes, depreciation and amortisation, with the owner’s economics removed and the company’s economics left behind.
The adjustments that survive scrutiny are the ones that are documented, non-recurring, and clearly attributable to the current ownership rather than to the operation of the business.
| Adjustment | Defensibility |
|---|---|
| Owner compensation above a market rate for the role | Strong, with a documented market rate |
| Rent on a related-party property above market | Strong, with an appraisal or comparable leases |
| One-time legal settlement, clearly closed | Strong |
| Personal vehicles, travel, family members on payroll | Defensible, if itemised and consistent |
| Non-recurring systems implementation | Defensible, if the spend genuinely ends |
| “Lost revenue” from a customer that left | Aggressive, almost never accepted |
| Deferred maintenance the buyer will now have to fund | Aggressive, and often reversed against you |
A useful discipline: assume every add-back will be read aloud by a sceptical accountant to an investment committee. The ones you would not want read aloud should not be in the schedule.
Where the multiple comes from
The multiple is best understood as a risk assessment expressed as a number rather than as a market price. It is built from five things.
- Sector. A baseline set by what acquirers in that industry have recently paid. This is the only input that is genuinely external.
- Size. The strongest single driver in this market. A company with $2M of EBITDA and one with $10M in the same sector are not priced on the same scale, because the second has management depth, survives the loss of a customer, and is financeable.
- Growth. Demonstrated and explainable, not projected. Three years of evidence is worth more than a five-year model.
- Revenue quality. Contracted or recurring revenue commands a premium over repeat-but-uncommitted, which commands a premium over project work.
- Risk. Customer concentration, key-person dependence, regulatory exposure, deferred capital expenditure, and the state of the financial record itself.
Two of those are within an owner’s control on a two-year horizon: revenue quality and risk. Most of the value we create before a process begins is created there, not in the negotiation.
The size effect, stated plainly
Larger companies trade at higher multiples for structural reasons rather than sentimental ones. A buyer of a $2M EBITDA company is acquiring a concentration of risk in one or two people, where a buyer of a $12M EBITDA company is acquiring an organisation. The second is financeable on senior debt at better terms, which directly raises what a financial buyer can pay while still hitting the same return, and the multiple reflects that arithmetic.
This has a practical consequence owners underuse. If a company is close to a threshold where the buyer universe changes, meaning the point at which private equity platforms rather than individuals become credible acquirers, then two years of disciplined growth can be worth more than any negotiating strategy.
The three discounts
Customer concentration
The most consistently applied discount in this market, and the one most frequently mishandled. A single customer at 30% of revenue does not merely reduce the multiple; it changes the structure, pushing consideration into an earnout tied to that customer’s retention.
The mitigation is not concealment. Diligence finds it in week two, and the discovery costs more than the fact itself. The mitigation is context, disclosed up front: contract length, tenure, the number of individual relationships inside that account, the share of that customer’s own spend you hold, and what happened the last time they tendered.
Key-person dependence
If the owner holds the customer relationships, the pricing authority, the vendor terms and the technical knowledge, then the buyer is acquiring a company that does not fully exist without a person who is, by definition, leaving. Buyers respond with earnouts, extended transition agreements, and a lower number.
The fix takes eighteen months and is unglamorous: a second-in-command with actual authority, documented processes, and customer relationships that are deliberately introduced to somebody else.
Quality of the financial record
This is the discount owners notice last. Cash-basis books, inconsistent revenue recognition, inventory that has never been counted properly, personal and business expenses commingled beyond reconstruction. None of this changes the economics of the business. All of it changes the price, because the buyer prices uncertainty and the lender will not lend against numbers that cannot be tested.
A sell-side quality-of-earnings review costs a fraction of the discount it removes, and it is the only diligence expense we recommend without qualification.
What a valuation is for
A valuation delivered as a single number is of limited use. It becomes useful when it does three things: establishes a defensible range, documents the basis well enough to survive a buyer’s challenge, and names the specific items holding the number down together with what each is worth if it is addressed.
The third of those is what an owner can actually act on, and it is the difference between a report and a plan.
