Why does valuation matter so much?
Overpaying is the most common and least recoverable mistake in buying a business. If you pay too much, you carry the extra debt for years while earning the same profit anyone else would. A disciplined valuation also gives you a basis for negotiation and helps you work out how much acquisition funding the business can actually support.
What are the main valuation methods?
| Method | How it works | Best suited to |
|---|---|---|
| Capitalised earnings | Maintainable profit × a multiple reflecting risk | Most profitable, established SMEs |
| Owner’s earnings (SDE) | Profit before owner’s wages and discretionary costs × multiple | Very small, owner-operated businesses |
| Net assets | Value of assets less liabilities | Asset-heavy or marginally profitable businesses |
| Comparable sales | Prices paid for similar businesses | Industries with active markets, such as franchises |
For most established SMEs, the capitalised earnings method is the anchor, with the others used as cross-checks.
Step 1: work out maintainable earnings
Start with at least three years of financial statements plus the current year’s management accounts. Then adjust the profit to reflect what a new owner could reasonably expect to earn.
Common adjustments:
- Owner’s wages. If the owner takes drawings rather than a salary, deduct what it would cost to employ someone to do their job. This is the single biggest adjustment in many small businesses.
- One-off items. Remove genuinely non-recurring income or costs, such as an insurance payout or a one-off legal bill.
- Related-party costs. If the business rents premises from the owner’s family trust at a below-market rent, adjust to market rent.
- Personal expenses. Vehicles, phones and travel run through the business for personal use can be added back, but only with evidence.
- Interest and depreciation. Depending on the measure used (EBIT or EBITDA), adjust consistently.
Be sceptical of “add-backs” that the vendor cannot evidence. If a cost is needed to run the business, it is not an add-back.
Step 2: choose a sensible multiple
The multiple reflects how confident you are that the earnings will continue. Factors that lower the multiple include:
- heavy reliance on a few customers
- a business built around the owner’s personal relationships or skills
- short or insecure leases
- key staff who may leave
- an industry facing decline or disruption
- inconsistent earnings over recent years
Factors that raise it include diverse customers, recurring revenue, documented systems, a capable management team and a long lease.
Ask a business broker or accountant familiar with your industry about recent comparable sales. Be wary of rules of thumb quoted without context.
Step 3: add stock, and check the assets
Most New Zealand business sale agreements treat stock at valuation separately. Stock is counted just before settlement and paid for on top of the agreed price for goodwill and chattels. Check that stock will be valued at cost, and that obsolete or slow-moving items are excluded or written down.
Review the plant and equipment list. Is it owned outright? A search of the Personal Property Securities Register shows whether any lender has a security interest over it. Equipment on finance may need to be paid out at settlement.
Step 4: think about working capital
A business needs working capital to operate: debtors, stock and cash to pay wages before customers pay. Some sale agreements leave debtors and creditors with the vendor, which means the buyer starts with no incoming receipts but immediate outgoings. Budget for this, and consider whether some funding should be kept for working capital.
A worked example
Illustrative figures only.
| Item | Amount |
|---|---|
| Reported net profit before tax | $310,000 |
| Add back: owner’s drawings recorded as wages | $0 (owner took drawings) |
| Deduct: market salary for the owner’s role | −$110,000 |
| Add back: one-off legal costs (evidenced) | $15,000 |
| Deduct: adjust related-party rent to market | −$20,000 |
| Maintainable earnings (EBIT) | $195,000 |
| Multiple chosen after risk review | 2.5 |
| Value of goodwill and plant | $487,500 |
| Plus stock at valuation on settlement | ~$60,000 |
The vendor’s asking price was $650,000 plus stock. The buyer’s adjustments show why the price needs negotiation.
Step 5: test affordability
Finally, check the price against what the business can afford to repay. If you plan to borrow, model the repayments against maintainable earnings after your own salary, with a buffer for a slower first year. If the numbers only work in the best case, the price is too high or the funding structure needs rethinking. Vendor finance or an earn-out can bridge a gap in expectations.
Get professional help
A business purchase is a significant commitment. Business.govt.nz recommends engaging an accountant and lawyer early. Your accountant can verify the numbers and advise on tax, including GST on a going concern, and your lawyer can protect you in the agreement. Then use our due diligence checklist to confirm what you are buying.
Quick answers
What multiple do small businesses sell for in New Zealand?
There is no single figure. Multiples depend on the industry, size, earnings stability and how dependent the business is on the owner. A broker or accountant familiar with your sector can advise on recent comparable sales.
Should I pay for goodwill?
Goodwill is the premium paid above the value of tangible assets for the business's ability to earn profit. It is worth paying for when earnings are sustainable and transferable to you. It is worth much less if customers are loyal to the vendor personally.
Is GST charged on the purchase of a business?
The sale of a business as a going concern between GST-registered parties can be zero-rated if the agreement meets the requirements. Your accountant and lawyer should confirm the treatment before signing.
Can I borrow against the goodwill?
Lenders rarely lend against goodwill on its own. Acquisition funding for SMEs is often secured on property the buyer already owns. See funding to buy an established business.