Which bridge you’re on
Buyers price a business on the highest measure of earnings it can prove. This page shows the measures in order, who pays on each, and how a business is placed between two of them.
Six measures of earnings, each harder to prove
Every buyer values a business on some measure of what it earns. The measures run in a fixed order, and each one asks for more proof than the one before. A business is priced on the highest measure it can defend to the buyer in front of it.
- TractionNo one yet: value rests on the story, the product and the market.
- SDEAn owner-operator who will run it.
- Adjusted EBITDAA buyer who won’t run it: a fund, a search investor’s backers, a strategic.
- Free cash flow to the firmA buyer who models rather than multiplies.
- Free cash flow to equityAn equity buyer alongside a lender.
- Cash available for distributionAn income investor or a family that never sells.
Each step up the line is called a bridge: the crossing from one measure to the next. The measures are anchors; the bridge is the arrow between two of them.
The measure. Revenue, customers and a product people pay for.
Who prices it. No one yet: value rests on the story, the product and the market.
The measure. Seller’s discretionary earnings: profit plus one owner’s full pay and perks.
Who prices it. An owner-operator who will run it. Won’t pay for add-backs they can’t verify, or revenue that leaves with the seller.
The measure. Profit with the owner paid at market and only defensible one-time items added back.
Who prices it. A buyer who won’t run it: a fund, a search investor’s backers, a strategic. Won’t pay for earnings that depend on the owner.
The measure. The cash the operations throw off after tax, upkeep spending and working capital.
Who prices it. A buyer who models rather than multiplies. Won’t pay for EBITDA that doesn’t turn into cash.
The measure. The cash left for owners after the debt is served.
Who prices it. An equity buyer alongside a lender. Won’t pay for cash flow that can’t carry its own debt through a bad quarter.
The measure. What can be paid out year after year without starving the business.
Who prices it. An income investor or a family that never sells. Won’t pay for a payout that exists only on paper.
How to read it. Read left to right. The further along a business is, the more of its earnings a buyer can verify, and the more kinds of buyer can pay for it.
How a business is placed
Placing a business is a test, not an opinion. The checkpoints for each anchor are run in order, and the run stops at the first one the business can’t pass. The document it can’t produce names the work.
Each anchor has a checkpoint list: the documents and records a buyer at that anchor inspects, each with a bar to clear. The checkpoints are run in order, starting from the lowest anchor, and the run stops at the first failure. A business is on exactly one bridge: from the highest anchor it can defend to the next one it can’t. The missing document names the stretch of the bridge to work on.
- One bridge at a time. A business sits on exactly one bridge: the highest anchor it can defend, and the next it cannot
- Inspection equals deliverables. The list one bridge must produce is exactly the list the next anchor’s checkpoint inspects
- Traffic both ways. A business sliding back is valued at the highest anchor it can still defend, with the record it has rather than the record it had
- Four discounts. Every target is tagged with the buyer’s discount it removes: magnitude (the number is smaller than claimed), certainty (it can’t be verified), durability (it won’t last) or growth (it won’t grow)
The sample, read against the checkpoints
Read against the checkpoints for adjusted EBITDA, the sample business has the earnings and much of the record, and is short on the paperwork a buyer who won’t run the business asks for. It reads as a business crossing from owner’s earnings to adjusted EBITDA.
In hand
- Three years of statements and the trailing twelve months, with the one-time items backed by invoices
- A customer schedule by account, with churn and retention computed from the billing export
- Five regulatory gates clear on the company’s word, a second layer of four managers running the day-to-day
Still to produce
- Statements reviewed by an outside accountant (the sample’s are not reviewed, compiled or audited)
- A third-party benchmark for the owner’s market salary, which is stated but not yet evidenced
- Employment, non-solicit and invention-assignment agreements for the second layer
- A data room with owners for every folder
What the crossing to adjusted EBITDA produces
This is the list the next anchor’s checkpoint inspects, so it is also the finish line for the crossing.
The nine deliverables
- Thirty-six months of accrual-basis statements reviewed by an outside accountant, with a proof of cash
- Three years of filed tax returns reconciled to the statements, every difference scheduled
- An organization chart with a named lead for every function at benchmarked pay, the owner in at most one costed seat with a named successor
- A documented owner absence, with revenue and delivery figures for the period
- Written procedures for each core operating function
- An add-back schedule reduced to documented, historical, non-recurring items
- Related-party arrangements at market under written agreements, or unwound
- A customer schedule showing concentration and year-over-year revenue retention
- Contracts with every material customer and supplier in the company’s name
Higher isn’t always better
Each crossing adds cost: reviewed and then audited statements, a management layer, a board, a payout policy. A business whose likely buyers price on owner’s earnings never earns that cost back. So the destination is chosen first, from the buyers you will actually face, and only then is the work planned to get there.
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