The discount for owner dependence is the profit that leaves with the owner, and a seller transition is the cheapest way to keep it.
Discount an owner-dependent business by the profit that leaves with the owner, not by a rule-of-thumb percentage: revenue tied to the owner, times the share of it expected to leave, times the margin it carries, times the multiple. On an illustrative print business asking $1.95 million at 3.0 times SDE, with 35 per cent of revenue tied to the owner and 30 per cent of that expected to leave, the loss is $134,400 of SDE and the business is worth $1.55 million, a 20.7 per cent discount. A 12-month transition that holds attrition to 10 per cent is worth $268,800 to the buyer.
Worked in full in Buying a Small Business by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Every listing for a small business says the owner "works in the business". The question for a buyer is which part of the revenue is bought from the company and which part from the person. Customers who call the owner's mobile, quote by quote, are loyal to that relationship, and some of them will not transfer it to a stranger. That revenue goes, but the costs that served it mostly do not go at once; what leaves is the contribution margin on it. Valuing that loss explicitly is what turns "owner dependence" from a vague worry into a number that can be negotiated.
| Item | Value |
|---|---|
| Revenue | 3,200 |
| Seller's discretionary earnings (SDE) | 650 |
| Asking multiple of SDE | 3.0x |
| Asking price | 1,950 |
| Revenue tied personally to the owner | 35% |
| Contribution margin on that revenue | 40% |
| Expected attrition of owner-tied revenue, no transition | 30% |
| Expected attrition with a 12-month seller transition | 10% |
| Cost of the transition agreement | 90 |
The owner-tied share comes from the customer list: rank the accounts, ask the seller who manages each one, and check the answer against who signs the quotes and who answers the emails. The attrition rates are judgement, and the sensitivity table below is there because of it.
Owner-tied revenue = 3,200 × 35% = 1,120
Revenue lost = 1,120 × 30% = 336
SDE lost = 336 × 40% contribution margin = 134.4, 20.7 per cent of SDE
Adjusted SDE = 650 − 134.4 = 515.6
Value = 515.6 × 3.0 = 1,546.8, against an asking price of 1,950: a discount of 403.2, or 20.7 per cent
Excel: =(SDE-Revenue*OwnerShare*Attrition*CM)*Multiple
The discount happens to equal the share of SDE lost because the multiple is held constant. Read on the seller's figure, the buyer is paying 2.38 times SDE, which is a fair price for the business that will actually exist after the sale.
The loan sees the same thing. Financing 90 per cent of the asking price, $1.755 million over ten years at an illustrative 10.5 per cent, costs 284.2 a year. After a 100 salary for the buyer, the plan's coverage is 1.94 times; with the owner-tied attrition it falls to 1.46. Still above a lender's floor, but the margin for anything else going wrong has gone. The coverage test itself is worked in what purchase price a 1.25x DSCR supports.
A seller who stays for a year, introduces the buyer to every owner-managed account and hands them over in person cuts the attrition. At 10 per cent, the lost revenue is 112, the lost SDE 44.8, adjusted SDE 605.2 and the value 1,815.6, so the transition adds 268.8 of value. Its 90 cost pays back in one year of the 89.6 of SDE it saves, and the buyer is still 178.8 ahead after paying it. Coverage on the asking price recovers to 1.78 times.
SBA 7(a) rules do not allow earn-outs on a change of ownership, and they limit how long the seller can stay on, so on an SBA deal the protection has to come from the price, a defined transition agreement and the seller note, not from a contingent payment. Check the current SOP with the lender before drafting.
| Owner-tied share of revenue | Attrition 10% | Attrition 30% | Attrition 50% |
|---|---|---|---|
| 20% | 1,873.2 (3.9%) | 1,719.6 (11.8%) | 1,566.0 (19.7%) |
| 35% | 1,815.6 (6.9%) | 1,546.8 (20.7%) | 1,278.0 (34.5%) |
| 50% | 1,758.0 (9.8%) | 1,374.0 (29.5%) | 990.0 (49.2%) |
The range is wide: from a discount small enough to absorb in the negotiation to half the price. That is the honest answer to "how much should I discount an owner-dependent business": it depends on two numbers the buyer can investigate before signing, the owner-tied share and how many of those customers will stay, and the second depends largely on what the seller agrees to do after closing. Concentration in a single customer is a different risk with a similar arithmetic, worked in how much customer concentration reduces a small business's value.
Cutting the price by the share of revenue at risk. Here that is 35 per cent × 30 per cent, or 10.5 per cent, which would value the business at 1,745.2 and understate the loss by roughly half. The error is that revenue is not profit: lost revenue takes its contribution margin with it, 40 per cent here, while SDE is only 20.3 per cent of revenue, so each lost dollar of revenue removes about twice its average share of profit. The other mistake is the opposite one: deducting the whole owner-tied revenue as if every customer would leave, which no buyer can finance and no seller will accept.
The book works its own deals, an HVAC contractor and a commercial cleaner, from broker SDE through to the cash the business actually generates, with both models in the free workbooks for the book's two deals.
Value the owner dependence as SDE lost: revenue × owner-tied share × attrition × contribution margin, then apply the multiple. Here that is 134.4 of SDE and 403.2 of price. Then price the cure: a transition that holds attrition to 10 per cent is worth 268.8, about three times its cost.
Estimate the revenue tied personally to the owner, the share of it likely to leave after the sale and the contribution margin it carries, then deduct the lost profit from SDE before applying the multiple. On the illustrative case, 35 per cent of $3.2 million of revenue is owner-tied, 30 per cent of it leaves, and 134.4 thousand of SDE goes, taking the value from 1,950 to 1,546.8 thousand.
Usually, if it measurably reduces customer losses. In the illustrative case a 12-month transition cut expected attrition of owner-tied revenue from 30 to 10 per cent, saving 89.6 thousand of SDE a year and adding 268.8 thousand of value at 3.0x, for a 90 thousand cost: a one-year payback.
Because lost revenue removes its contribution margin, not its average profit. With 35 per cent of revenue owner-tied and 30 per cent attrition, the revenue at risk is 10.5 per cent, but at a 40 per cent margin against a 20.3 per cent SDE margin the profit lost is 20.7 per cent, so the revenue shortcut understates the discount by about half.
This article is one calculation from Buying a Small Business. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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