Why Two Identical Shops Sell for Millions Apart

For 22 years he built a plumbing and mechanical company that paid him more than $900,000 a year. He had told his wife they were set, and he believed it. When a buyer came knocking, he had his number in his head, something close to what two decades of work was worth. The offer came back at less than half of it, and most of that was tied to him staying on three more years while the company hit targets he wouldn't be able to control. The business was profitable. It had always been profitable, and for the last decade it was more than $500,000 a year profitable. His mind kept circling back to one question. What is wrong with me?

Nothing was wrong with him. He had run into the difference between an income-value business and an enterprise-value business, and like most owners, he learned about it with the offer already on the table.

If you own a mechanical contracting business doing seven to eight figures a year in revenue, you may be standing right where that contractor stood and not know it, because a high income is one of the quietest forces working on an owner. It convinces you the business under it is as solid as the money it throws off. The difference usually shows up only when someone tries to buy you, and by then it's too late. Take two contractors with the same revenue and the same profit, and look at why one gets the number he was dreaming of while the other gets the one that ruins his retirement.

Call them Contractor A and Contractor B. Both run shops doing about $6 million a year, and both clear close to $1 million in EBITDA. Each owner has paid himself more than $600,000 a year for as long as he can remember. On every number the owner cares about, the two businesses are identical.

Before a buyer makes an offer, he settles one question: How sure can he be that the revenue and the profit will continue once the owner is gone? On that question, Contractor A and Contractor B stop looking anything alike. A buyer hunts for that answer in four places.

Recurring Revenue

The first place he looks is the revenue itself. Almost all of Contractor A's $6 million comes from project work, new construction, remodels, and big replacement jobs he wins one bid at a time. When a job finishes, that revenue is finished with it, and the next $6 million has to be found and bid and won all over again. Maybe 15 percent of his book renews on its own. Contractor B has close to 65 percent of his revenue coming from service agreements and maintenance contracts, work that shows up on a schedule whether or not anyone is out selling it. His $6 million mostly renews itself.

What a buyer is purchasing is next year's revenue, the $6 million that has not happened yet, and that is where the two men separate. Contractor A's next year is a blank page. He has filled it for over a decade, and that decade belongs to him. When the company changes hands, the buyer inherits the empty page and has to fill it himself, in a market that has no reason to keep saying yes to him. Contractor B's next year is mostly already written, sitting in contracts that renew on their own.

Customer Concentration

The second place a buyer looks is who the revenue comes from. Contractor A has one builder that accounts for about 40 percent of his work, and his top three customers together make up close to two-thirds of it. He is proud of that builder. They have worked together for 15 years, the relationship is solid, and as far as he is concerned it is the most dependable thing he has.

Contractor B's revenue is spread across dozens of accounts, and his largest customer is barely 10 percent of the total. No single client can move his revenue much in either direction.

To Contractor A, that builder is security. To a buyer, it is one of the most fragile things in the business. Accounts disappear for reasons that have nothing to do with the quality of the work. The builder gets acquired, the builder doesn't like the new owner, or a competitor comes in a few dollars cheaper, and 40 percent of the revenue disappears overnight. For Contractor B, losing his biggest account is a rough quarter. For Contractor A, it is the kind of event a business does not always survive.

Founder Dependency

The third place a buyer looks does not show up on any report, which is why it is often neglected.

Contractor A is the business. He holds the relationships, makes the calls, and is the final word on anything of significance. Nothing important happens without passing through him, and he is proud of that, because it is true and he earned it.

Contractor B built something different. He has an operations manager who runs the day to day and the authority to make decisions, and a team that handles the work without him in the middle of it. He could be in the hospital for a month and the numbers would not move.

A buyer is not purchasing the owner. The owner is the one piece of the company that will not be there anymore. So the only question that matters is whether the business's output survives his exit, and for Contractor A it does not, because the performance runs on him. The very thing he is proudest of is the thing that worries a buyer most. The more the business needs you, the less it is worth to anyone who is not you.

This is why the offer in the story at the start came with three more years attached. Those years were the buyer pricing the risk that the business and the man were the same thing.

Documented Systems

The fourth place a buyer looks is how the work gets done, whether the knowledge that runs the company is written down or carried around in people's heads.

Contractor A's company works, but the knowledge that makes it work lives in memory and habit. Estimating is done the way it has always been done, priced by experience, but never written down. The best installer handles the hard jobs because he has done a thousand of them. There is no process underneath it, just him.

Contractor B put that same knowledge into documented systems. His estimating, pricing, and job standards are written down, where a new team could pick them up and run.

Contractor A's know-how can walk out the door the week a key employee quits, and a new hire cannot simply be handed the job. Contractor B's know-how stays with the building. To a buyer, one of those is an asset he can own, and the other is a risk he inherits.

This is also the factor owners believe they can fix on the way out the door. They can write up some procedures, build a binder, and call it a system. It can't be a system if no one follows it. A system is the knowledge living in how the work actually gets done, followed when no one is watching, and that takes time. The weeks before a sale are far too late to start.

The Result

The buyer valued Contractor A at three times EBITDA, which on $1 million is a $3 million offer. He valued Contractor B at seven times the same EBITDA, a $7 million offer. Same revenue, same profit, more than twice the money. That $4 million is the difference between hitting the number you spent your career chasing and wondering what is wrong with you. Every dollar of that gap came from how the two companies were built.

Underneath all four factors there is a single question: Can the money keep coming once the owner is gone? The answer is the entire difference between an income-value business and an enterprise-value business. Contractor A built an income. He built a very good one, and it ends the day he stops running the business. Contractor B built an asset that also happened to pay him well, and it keeps running after he is gone.

For 22 years he built a plumbing and mechanical company that paid him more than $900,000 a year. He had told his wife they were set, and he believed it. When a buyer came knocking, he had his number in his head, something close to what two decades of work was worth. The offer came back at the number, and then climbed above it. Nothing was tied to him staying on, no three years of proving the company could survive him, because the buyer could already see that it would. The business was profitable. It had always been profitable, and for the last decade it was more than $500,000 a year profitable. His mind kept circling back to one question. What will I build next?