What your books are worth when you sell

Whether you sell in two years or ten, the price is decided by what you can prove. Not what the business earns — what you can demonstrate it earns, in documents a stranger can verify.

That distinction is worth a lot of money, and it cannot be created retrospectively.

How contracting businesses get valued

Most sales at this size are a multiple of adjusted earnings — commonly referred to as SDE for owner-operated businesses, or EBITDA for larger ones with management in place.

Two numbers decide the price: the earnings figure, and the multiple applied to it. Your books influence both.

Add-backs, and why they need documenting as you go

Adjusted earnings means reported profit plus things a new owner would not incur: your above-market compensation, the truck the household drives, personal phone lines, a family member on payroll who does not work in the business.

Every add-back increases the price — if you can evidence it.

Here is the problem. Add-backs argued for during diligence, from memory, against a buyer's accountant, mostly get discounted. Add-backs that are visible in the books as consistent, clearly coded entries get accepted with barely a conversation.

Same underlying reality. Very different outcome, decided entirely by whether somebody recorded it at the time.

What moves the multiple

Two businesses with identical earnings do not fetch identical prices. The multiple reflects how risky the earnings look to somebody who is not you.

Owner dependence. If every relationship, every quote and every technical decision runs through you, the buyer is buying a job. That depresses the multiple more than anything else on this list.

Recurring revenue. Maintenance agreements and recurring service contracts are worth disproportionately more than one-off work, because they persist through a change of ownership. This is the strongest argument for pricing and tracking agreements properly long before you sell.

Customer concentration. One customer at forty percent of revenue is a risk the buyer prices in.

Clean, consistent financials. Three years that agree with each other and with the tax returns.

Documented processes. The business runs on systems rather than on what is in your head.

What diligence will ask for

Expect, at minimum:

• Three years of financial statements, internally consistent
• Three years of tax returns that reconcile to those statements
• Current interim financials
• Job-level profitability history
• Customer list with revenue concentration
• Backlog and work in progress
• Equipment list with condition and any finance against it
• Payroll records and contractor classification
• Insurance history including workers comp

The two that most often cause trouble are financials that do not reconcile to the tax returns, and worker classification — an unresolved 1099 versus W-2 question is a real liability a buyer will either price in or walk from.

Why "start three years out" is the actual advice

Buyers look at three years. So the books you keep this year are being examined in a sale you may not have decided on yet.

If you clean up six months before going to market, the buyer sees two messy years and one tidy one, and reasonably assumes the tidy one was staged.

Nothing here requires deciding to sell. Clean books, documented add-backs, tracked recurring revenue and reduced owner dependence are the same things that make the business better to own. The sale price is a by-product.

The uncomfortable one

Under-reporting income to reduce tax also reduces your sale price, at a multiple.

A dollar of hidden profit saves you the tax on that dollar once. It costs you that dollar times the multiple when you sell — often several times the saving. Owners are frequently surprised by this arithmetic, and by then it is too late to change three years of history.

Related

• How much should I pay myself?
• Separating business and personal money
• The eight numbers a contractor should look at every month

General information about how these transactions are typically structured, not financial, tax or legal advice. Get a broker, a CPA and a lawyer involved well before you go to market.