Four Reasons the Smaller Company Trades Lower, All of Them Fixable

Larger companies sell for higher multiples of the same earnings, and the gap is not small.

Owners hear that and assume it is a market inefficiency, or that institutions simply prefer size. It is neither. There are four specific reasons the smaller company gets discounted, they are mechanical rather than sentimental, and every one of them is something you can change without changing your revenue.

Reason one: the buyer is not purchasing a job

A larger company usually has management below the owner. A smaller one frequently does not, which means what is for sale is a job with equipment attached.

This is the whole of it for a great many companies. Ask what happens to the business in the ninety days after you stop answering the phone. If you hold the customer relationships, the pricing judgment, the supplier terms, and the institutional memory, then the buyer is not acquiring an enterprise. They are acquiring your calendar, and they will price it accordingly, assuming the worst version of the transition because they have no way to assume anything else.

Reason two: losing one customer is survivable

More customers means a single departure does not reset the business.

The question a buyer asks is what happens if the largest customer leaves. If the honest answer is “very little,” you have no concentration risk and you will be paid for it. If the answer is a material share of revenue and a relationship that exists because of you personally, the buyer is pricing the possibility that they bought the company and lost the reason it earned money.

Reason three: it can carry acquisition debt

A company large enough to service acquisition debt can be bought by anyone who borrows, which is most institutional buyers.

That single fact widens the field of parties who can pay for it, and the field is what produces the price. A company too small to finance is limited to buyers paying cash out of their own resources, and buyers paying cash out of their own resources are both fewer and more disciplined.

Reason four: institutions compete with each other

Above a certain size a company becomes interesting to institutional buyers, and institutional buyers compete in a way individual buyers do not.

They do this constantly, they are well capitalized, and when one of them wants a platform in your sector they will pay up for it. It is sometimes said that financial buyers do not pay premiums. Do not plan on that. What is true is that they are disciplined: they will pay a strong price for a business that fits their model and walk away from one that does not, without the hesitation an individual buyer would feel.

All four are the same sentence

If you want to raise the value of your business, lower the risk to the buyer.

Management depth lowers transition risk. Customer diversification lowers revenue risk. Size enough to carry debt lowers the financing risk for the buyer. A field of institutional buyers lowers the risk that you are negotiating with one party. Every item on any list of value drivers is a version of that sentence, which is why the list can look arbitrary until you see what it is actually measuring.

Which means the multiple is partly a decision

This is the part that matters, and it is the reason the gap is worth understanding rather than resenting.

You cannot change your revenue to eight million dollars by Friday. You can change the reasons the multiple is lower, and they are addressable on a two or three year horizon: a layer of management that genuinely runs things, a customer base where no single account is structural, a financial record clean enough to finance against, and a company presented to the buyers who compete rather than the ones who happen to call.

That is the argument for starting this two or three years before you intend to sell rather than two or three months. Not because preparation polishes a document. Because preparation changes which of the four reasons still apply to you.

The interim results trap

One thing moves in the opposite direction and catches owners mid-process.

Buyers buy the future and the best available evidence of it is the present. Strong current performance supports a higher price. A dip during the process drags on pricing no matter what the trailing years say, because a current fact is more persuasive than a historical one.

Which means the preparation that raises the multiple has to happen without the owner’s attention leaving the business, and that is exactly the period when an owner running their own sale is least able to deliver it.

What getting it wrong costs

Nothing announces itself. The multiple simply comes in where it comes in.

An owner who never learns why sells a company at the number appropriate to its risk profile and concludes that is what companies like theirs are worth. The same company, with a general manager who has been running it for two years, a largest customer at a share nobody worries about, and a financial record a lender will underwrite, is a different asset in a different market with a different set of bidders.

The earnings did not change. The reasons to discount them did.

More on this: The Difference Between Buying an Income and Buying a Hope.

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This is what we do. Prism Edge works the four reasons rather than the document: building the management layer into something a buyer can verify, reducing concentration where it is reducible, getting the financial record to a state a lender will finance against, and then taking the company to the buyers who compete for it. The multiple is partly an outcome of that work, and the work takes longer than a sale does.

The full chapter on what drives value is in The Business Sale, free to download here.