Why Two Companies With the Same Earnings Sell for Different Money

Earnings set the starting point. Risk sets the multiple. Almost everything owners get wrong about value comes from attending to the first and ignoring the second.

Put two companies side by side. Same industry, same adjusted earnings, same year.

The first depends on its owner for the biggest customer relationships, has 40% of revenue in one account, keeps its books on a system nobody outside has reviewed, and has no one who could run it for a month.

The second has a second line of management, its largest customer under 10%, reviewed financial statements, documented procedures, and spare capacity.

The second one trades at a materially higher multiple. No amount of negotiation closes that gap, because the gap is not a negotiating position. It is the buyer pricing what could go wrong after you leave.

What a buyer is actually buying

He is not buying last year’s earnings. He is buying his estimate of next year’s, discounted by how confident he is in it.

Everything that makes him less confident costs you multiple. That is the entire mechanism, and once you see it the list of things that matter stops being mysterious:

• Customer concentration. What happens to this company if the largest account leaves? If the honest answer is “not much,” you have removed his single biggest fear.
• Owner dependence. How much of the revenue exists because of you personally? A company that cannot run for a month without you is a company he has to replace you in.
• Management depth. Is there a second layer, and will it stay? He is buying people as much as assets.
• Quality of the financial information. Reviewed or audited statements by an independent firm price better than internal ones, for the simple reason that he has to trust the number he is multiplying.
• Documented process. What lives in someone’s head is a risk. What is written down is an asset.
• Contract quality and length. A six-month arrangement is not a six-year one, and a customer willing to sign a term says something about you that you cannot say about yourself.
• Growth capacity. What revenue could this business support with no further investment, and what breaks first? An owner who can answer that precisely is describing upside the buyer can underwrite.

If you want to increase what your business is worth, lower what the buyer has to worry about. That is the whole sentence.

Why the multiple you heard at a conference is not your multiple

The most common method owners use is earnings times a number someone mentioned at an industry dinner. It feels like math. It is a guess wearing math’s clothes, because it skips both questions that determine the answer — what your earnings actually are once they are normalized, and why anyone would pay that multiple for your company rather than the average one.

Comparable transactions are better evidence, and the difficulty is never finding numbers. It is knowing which of them are comparable to you. Two companies in the same industry at the same earnings get priced very differently on the list above, and on who the buyer was and why they wanted it. A figure drawn from companies that do not match you on those dimensions is a coincidence with a decimal point.

Working out which comparables are genuinely comparable is the whole of the exercise, and it is judgment rather than retrieval.

And a valuation is not a price

This is the distinction that costs people the most.

A valuation tells you what a methodology produces when applied to your numbers. It is a necessary document and it is not an offer. You cannot carry it to a buyer and expect that figure, because value is not a fixed standard — it is measured through the eye of the buyer, and different buyers have genuinely different eyes.

The strategic buyer who needs your geography is not valuing the same asset as the financial buyer who needs a return. One of them may pay a real premium for something the other will not pay a dollar for. Neither of them is wrong, and no formula predicts which one shows up.

So the only thing that produces a price is taking the company to the market and finding out. Everything before that is preparation for the question, not an answer to it.

What this means about timing

The list at the top is not a list of things to disclose well. It is a list of things to fix, and the fixing takes years rather than months.

Reducing a 40% customer to 20% is a sales strategy, not a diligence response. Building a second line of management is a hiring and retention program. Getting three years of reviewed statements requires having started three years ago. An owner who begins this work two or three years before going to market is operating on the multiple itself. An owner who begins it when a buyer calls is operating on the discount.

That is the difference between selling a company and being bought.

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This is what we do. Prism Edge works with owners on the things that move the multiple, well before anyone is at the table, and then runs the process that finds out what the market will actually pay. If you are two or three years out, that is the right time to talk.

And the full chapter on this is in Selling Your Business The Easy Way, free to download here.