Are You Selling the Same Business You're Asking the Buyer to Value?

Why the assets, people, and relationships that produce a company’s earnings matter just as much as the earnings themselves.

A Conversation I’ve Had Many Times

When I meet with business owners who are considering a sale, one of the first things we discuss is the company's earnings and what those earnings might suggest about its value.

But there is another question that is just as important:

Will the buyer receive everything the business currently relies upon to generate those earnings?

It may seem like an obvious question. Yet over the years, I've encountered many sellers who intend to retain equipment, vehicles, customer relationships, employees, or other resources that are important to the continued operation of the company.

Sometimes they want those resources for another business venture. Other times, they simply regard certain assets or relationships as personal to them rather than part of the company being sold.

The difficulty is that a buyer's valuation generally assumes the company will continue operating in substantially the same manner after the acquisition.

If the resources supporting its earnings are removed, the business being delivered may no longer be the business that was valued.

Earnings Don’t Exist in Isolation

Suppose a manufacturing company generates $600,000 in annual EBITDA.

A prospective buyer reviews its financial statements, equipment, customer base, employees, and operating history and determines that the business represents an attractive acquisition.

During negotiations, the seller explains that two specialized machines will not be included because they are needed for another venture.

Those machines have been used to manufacture products that contributed to the company's reported earnings.

The buyer now faces a choice: purchase replacement equipment, find an alternative production arrangement, or accept a reduction in operating capacity.

Each alternative has a cost.

The company's historical EBITDA may still be $600,000, but the buyer is no longer receiving all the resources that produced it.

That difference must be considered when determining value.

Equipment and Other Operating Assets

Equipment is often the easiest example because its contribution to the business can be relatively straightforward to identify.

A contractor may rely on specialized trucks, tools, and machinery. A manufacturer may depend on production equipment, molds, fixtures, or proprietary tooling. A service company may require vehicles, computer systems, or specialized technology.

A seller may believe that certain equipment has little value because it is fully depreciated on the company's books.

But accounting depreciation has little to do with whether the equipment remains necessary to generate revenue.

A machine with a zero book value may be essential to producing hundreds of thousands of dollars in annual earnings.

Conversely, equipment that is no longer used or needed may be excluded from a transaction without affecting operating performance.

The distinction is not simply what an asset is worth individually.

The more important question is whether the business can continue producing its earnings without that asset.

Employees Are Part of the Earning Capacity

Employees present a more complicated situation.

A company may depend heavily on an experienced production manager, a salesperson with longstanding customer relationships, or a technician who possesses specialized knowledge.

Sometimes sellers assume that these employees can be transferred to another company or retained for a new venture without affecting the value of the business being sold.

But the loss of a critical employee can materially change a company's operating capabilities.

The buyer may need to recruit a replacement, incur training expenses, or accept a temporary reduction in productivity.

In some cases, important knowledge or customer relationships may be lost entirely.

Employees are not property that can be transferred or guaranteed to remain with a business. Their continued employment depends on their own decisions and the opportunities available to them.

Nevertheless, the stability and experience of the workforce are important components of a company's value.

A seller who intends to divert key personnel should expect the buyer to evaluate the consequences.

Customer Relationships Cannot Simply Be Carved Away

Customer relationships can create similar problems.

Imagine a company with a diversified customer base and a strong record of repeat business.

During negotiations, the seller announces that several important customers will be retained for another venture or serviced personally after closing.

The buyer originally evaluated a business that included the revenue and earnings associated with those customers.

Removing them changes the transaction.

Even when the seller does not intend to take customers away, the buyer must consider whether those relationships depend primarily on the seller's personal involvement.

A business whose customers interact with an established sales and management team is generally easier to transfer than one where the owner personally controls every important relationship.

This is one reason customer diversification and management depth matter so much in business valuation.

Intellectual Property, Systems, and Facilities

Not every important operating resource appears as a separate asset on the balance sheet.

A company may depend on proprietary designs, manufacturing processes, software, customer databases, trade names, licenses, or other intangible assets.

Its operations may also depend on a particular facility, favorable lease, or specialized location.

If those resources will not be transferred or remain available after closing, the buyer needs to understand the consequences.

For example, a business may report strong profits partly because it occupies a facility under a favorable lease.

If the buyer cannot assume that lease and must relocate to more expensive premises, historical earnings may overstate what the buyer can reasonably expect to achieve.

A proper valuation must consider these circumstances.

Personally Owned Assets and Related-Party Arrangements

Another issue that frequently arises in privately held businesses involves assets owned personally by the seller or by a separate company under common ownership.

Commercial real estate is a particularly common example.

An owner may hold the company's building personally and charge the operating business rent that is substantially below market rates. This arrangement may have worked well for years, but it can distort the earnings used to value the business.

Suppose a company reports annual EBITDA of $500,000 while paying $60,000 in rent for facilities that would ordinarily command $150,000 annually.

If the seller intends to retain the real estate and lease it to the buyer at market rates, the company's normalized EBITDA would be approximately $410,000.

Reported EBITDA: $500,000. Additional market-rate rent: ($90,000). Normalized EBITDA: $410,000.

That $90,000 difference can have a substantial impact on business value.

The same principle works in reverse. If the business pays above-market rent to a property owned by the seller, an appropriate adjustment may increase normalized EBITDA, provided the buyer can reasonably obtain the lower occupancy cost.

Similar issues arise with personally owned vehicles, equipment leased from related companies, shared employees, and administrative services provided by another business controlled by the seller.

The question is not simply who legally owns an asset or who currently pays an expense.

The question is what it will reasonably cost the buyer to continue operating the business under normal commercial arrangements.

A seller can certainly retain personally owned real estate or other assets. But the business valuation must reflect the economic consequences of that decision.

When an essential asset is not being transferred, the buyer should have a commercially reasonable and dependable arrangement for its continued use.

Otherwise, the buyer may be purchasing a business whose historical earnings cannot be sustained under the proposed transaction terms.

The Same Principle Applies to Working Capital

This issue extends beyond equipment, employees, and customer relationships.

It also applies to working capital.

A company may require substantial inventory, accounts receivable, and supplier credit to maintain its normal sales cycle.

If the seller removes those operating resources without an appropriate adjustment, the buyer may need to contribute additional capital immediately after closing.

The business may still have attractive historical earnings, but it has become more expensive for the buyer to operate.

This is why working capital negotiations have become an important part of many business acquisitions.

The buyer needs not only the assets and relationships that produce revenue, but also the operating capital required to keep the business functioning.

What If the Seller Wants to Keep Something?

There is nothing inherently wrong with a seller retaining an asset or excluding part of the business from a transaction.

The important point is that the exclusion must be recognized when evaluating what is being sold.

If an asset is unnecessary to the company's continuing operations, it may be reasonable to exclude it.

If the asset is necessary, the parties need to consider its replacement cost, the effect on future earnings, and any operational disruption.

Sometimes the buyer and seller can agree on a transition arrangement, equipment lease, supply agreement, or other solution.

But those arrangements must be commercially reasonable and sufficiently reliable to support the buyer's expectations.

The objective should be to avoid a situation in which the seller receives a price based on an intact operating business while delivering something materially different.

Why This Matters Before a Business Goes on the Market

These questions should be addressed during the initial valuation process, not discovered shortly before closing.

Before establishing an asking price, owners should identify the resources necessary to maintain the company's earnings.

They should also consider whether any of those resources are personally owned, shared with another business, dependent on the seller's involvement, or otherwise difficult to transfer.

Doing so helps avoid unrealistic valuation expectations and unnecessary disputes with prospective buyers.

It also gives owners time to correct problems before bringing the business to market.

The Bottom Line

A company's value is not determined solely by its historical earnings.

Those earnings were produced by a combination of people, equipment, customer relationships, operating systems, working capital, and other resources.

The buyer must be able to continue using those resources—or have a realistic means of replacing them—if the business is expected to maintain its profitability.

A seller cannot reasonably expect to receive the value of an intact operating business while withholding essential parts of the operation.

The principle I return to in my conversations with sellers is straightforward:

The business being sold should come with everything it currently relies upon to generate the earnings on which its valuation is based.

YourBizValue provides general educational information, not a formal business valuation or individualized financial, tax, or legal advice.