How to value a business you want to buy: what a lender will actually fund
How to value a business to buy the way a lender does: the profit it uses, the addbacks that stand up, and what to do when the asking price is more than the bank will fund.
Reading time6 min read
CategoryBusiness guides
Written byThe bizbritain team
A lender values a business you want to buy on its maintainable profit, not on the asking price. It starts from the profit the business makes in a normal year. It strips out the one-offs, then lends against a share of what is left. That figure is often lower than the seller's number. This guide explains how to value a business to buy the way a lender does. It also covers what to do when the two numbers do not meet.
Section 01
How do you value a business you want to buy?
Start from the profit, not the turnover. A business that turns over £2m and keeps £80,000 is worth less than one that turns over £900,000 and keeps £200,000.
Two profit figures come up in almost every small business sale. Both are meant to show what the business earns for whoever owns it.
Owner's discretionary earnings. This is the operating profit plus the owner's own salary and benefits. It suits a business run day to day by one owner, because the buyer will step into that job and earn that money.
Adjusted EBITDA. This is earnings before interest, tax, depreciation and amortisation, with one-off items taken out. It suits a business with a manager in place, because the buyer will not be doing the owner's job.
Sellers often present the higher of the two. A lender will use the one that matches how the business will actually be run after you buy it. If you plan to hire a manager, the manager's salary comes off the profit before anything else is counted.
Step 1
Find the maintainable profit
Take the last three years of accounts and the current year's management figures. Look for the profit the business makes in an ordinary year, not the best year and not a year with a windfall in it.
Step 2
Test every addback
The seller will add costs back to the profit to show a higher figure. Some are fair. Some are not. The next section goes through the common ones.
Step 3
Apply a multiple with care
A price is usually a multiple of the maintainable profit. The right multiple depends on the sector, the size of the business and how much of it depends on the owner. Treat any figure you read online as a starting point, not an answer.
Step 4
Check the price against the debt
Work out what the loan repayments would be at the asking price. Then ask whether the maintainable profit covers them with room to spare. If it does not, the price is too high for the debt, whatever the multiple says.
Would the business still pay its way if profit fell by a fifth?
Section 02
Which addbacks stand up, and which do not?
An addback is a cost the seller says will not apply to you, so it is added back to the profit. A lender tests each one. In our experience these are the ones that come up most.
The owner's salary above the market rate
This usually stands up. If the owner paid themselves £90,000 and a manager would cost £45,000, the difference is a fair addback. The manager's salary is not.
Personal costs put through the business
A car, a phone or travel that was really personal can be added back. The seller should be able to show what the cost was and why it goes.
A genuine one-off
A legal dispute, a flood, a move to new premises. These stand up if they are truly unusual and the accounts show them as such. A one-off that happens every year is a running cost.
Family members on the payroll
This depends on whether they did the work. If a relative was paid for a role that still needs doing, the cost stays. If they were paid for no role, it can go.
Savings you might make later
These do not stand up. A lender lends against what the business earns now, not what you hope to cut from it. Keep those plans for your own forecast.
Section 03
Why the multiple you read online is not the one your lender uses
Sector guides and deal databases quote multiples for businesses that sold. Most of those businesses are larger than the one you are looking at. A bigger business with a management team, contracts and repeat customers usually sells for a higher multiple. A small firm that depends on its owner usually sells for a lower one.
So the multiple you read for your sector is often the top of the range, not the middle of it.
There is a second reason. A lender does not lend a multiple of profit. It lends what the profit can repay. It looks at the loan repayments against the maintainable profit and wants a margin left over. That margin is what protects both of you if a customer leaves or costs rise.
Does that mean the seller is wrong?
Not always. The asking price is the seller's view of what the business is worth to someone. The lender's figure is what the business can safely borrow. They are different questions, and they often give different answers.
Section 04
What do you do when the asking price is higher than the lender will fund?
This is the normal case, not the exception. The gap is closed in one of four ways, and most deals use more than one.
Put in more of your own money. A larger deposit reduces the loan and the repayments. Our guide on how much deposit you need to buy a business explains what lenders expect and what counts as a deposit.
Ask the seller to leave money in the deal. Part of the price is paid later, from the profits. That can be a fixed deferred payment or an earn-out tied to results. Our guide on how an earn-out works covers the terms to watch.
Borrow against the assets as well. Equipment, vehicles, property and unpaid invoices can support separate facilities. That adds to what the profit alone can carry.
Negotiate the price. A seller who has heard the same figure from two lenders may move. Your valuation work is your strongest argument, because it is built on their own accounts.
Which mix is right depends on the deal and on the lenders you approach. Some lend more against profit, some more against assets, and some prefer a strong seller loan note. A business acquisition finance broker can put the same figures to several lenders. You then know what each will fund before you commit to a price.
The habit to take from this guide is simple. Work out the lender's number before you agree the seller's. Then the gap is a negotiation, not a surprise.
This guide is general information, not financial advice. Applications are subject to status, affordability and lender criteria.
Got a question the guide didn’t answer? Talk to an advisor.
We’ve helped buyers fund deals from £25k to £10m across 100+ lenders. If you’ve read the guide and you’ve got a business in your sights, our advisors are on the phone now.