How Buyers Think When Evaluating Small Businesses for Sale
When a founder decides to sell their business, they are often presenting the culmination of years of obsession, sacrifice, and problem-solving. To the founder, the business represents a personal history and a proud legacy.
However, when a professional buyer looks at that same business, they do not see a legacy. They see a financial asset with a specific risk profile and a projected return on investment.
This disconnect is the primary reason deals fail or valuations disappoint. Founders tend to sell the past (what they have built), while buyers are purchasing the future (the cash flows they can expect).
Understanding the buyer's mental model is the single most effective way to prepare for an exit. When you can view your company through the lens of a sophisticated investor, you can systematically remove the risks that depress valuation and highlight the mechanics that drive premium pricing.
Here is how buyers actually evaluate technology-enabled businesses in the lower mid-market.
The Buy versus Build Calculation
Before a buyer opens a spreadsheet to calculate EBITDA multiples, they must answer a fundamental strategic question: Is it cheaper, faster, or safer to buy this company than to build it ourselves?
This is particularly true for strategic buyers, such as competitors or larger private equity-backed platforms. They have their own engineering teams and sales forces. Therefore, your business is competing not just with other sellers, but with the buyer's own internal capabilities.
Buyers look for "moats" that are difficult to replicate. These typically fall into three categories:
- Proprietary Technology: Intellectual property that would take years or significant capital to reproduce.
- Customer Inertia: A sticky customer base with high switching costs.
- Market Position: A brand authority or distribution channel that a new entrant cannot simply purchase with marketing spend.
If a buyer believes they can replicate your product in six months with a small team, your valuation will be capped at the cost of that development effort. To command a premium, you must demonstrate that acquiring your business buys them time or market share that is otherwise inaccessible.
The Quality of Revenue
Once strategic interest is established, the buyer moves immediately to financial diligence. However, they are rarely interested in headline revenue figures alone. They scrutinise the quality of that revenue. According to Bain & Company's 2025 Global Private Equity Report, revenue growth has historically driven 52 per cent of value creation in software buyout returns, but today's buyers are increasingly focused on the sustainability of that growth.
In the subscription economy and tech-enabled services, the gold standard is predictability. Buyers act as actuaries, trying to determine the probability of your revenue continuing after you leave.
The most critical metric here is Net Revenue Retention (NRR).
NRR measures the health of your existing customer base over a specific period, excluding new sales. It answers a simple question: If you stopped selling today, would your business grow or shrink?
The formula is: NRR = (Starting ARR + Expansion Revenue − Churn − Contraction) ÷ Starting ARR
- Starting ARR: Annual Recurring Revenue at the start of the period.
- Expansion Revenue: Upsells and cross-sells to existing clients.
- Churn: Revenue lost from departing clients.
- Contraction: Revenue lost from clients downgrading service.
A buyer views an NRR of less than 100 per cent as a "leaky bucket." It implies that the business must constantly hunt for new customers just to stand still. This increases customer acquisition pressure and lowers valuation.
Conversely, an NRR above 100 per cent (ideally 110 per cent or higher) indicates a "growth engine." It suggests the product creates increasing value for customers over time. Buyers pay significant premiums for high NRR because it guarantees future cash flow with lower sales effort.
The valuation impact is substantial. McKinsey research found that companies in the top quartile of valuation multiples achieved a median enterprise-value-to-revenue multiple of 24x, compared with 5x for their bottom-quartile peers. The top-quartile companies typically showed NRR rates of 113 per cent, meaning they grew 13 per cent without adding any new business. Their bottom-quartile counterparts achieved NRR of only 98 per cent. That 15-percentage-point gap in retention translated into nearly a 5x difference in how the market valued those companies.
Key Person Risk and the "Bus Factor"
Small businesses are often built around the sheer force of will of the founder. While this is necessary for the zero-to-one phase, it becomes a liability during an exit.
Buyers are terrified of "Key Person Risk." They ask themselves: What happens if the founder gets hit by a bus the day after the deal closes?
If the relationships with key clients, the product roadmap, or the cultural cohesion of the team live exclusively in your head, the business is not transferable. You are selling a job, not an enterprise.
Sophisticated buyers will look for evidence of a "second layer" of management. They want to see:
- Sales processes that are documented and repeatable, not reliant on the founder's charisma.
- Technical documentation that allows a new engineer to understand the code base without a guide.
- Key client relationships held by account managers, not the CEO.
The more the business relies on you personally, the more likely the buyer is to structure the deal with an "earn-out." An earn-out forces you to stay involved for years to receive the full purchase price, shifting the risk back onto your shoulders. To achieve a clean exit (cash at closing), you must make yourself redundant before you go to market.
Balancing Growth and Profitability: The Rule of 40
A common point of confusion for founders is whether buyers prefer high growth or high profitability. The answer is usually "both," but there is a framework buyers use to assess the trade-off. This is known as the Rule of 40.
This principle states that for a healthy software or tech-enabled business, the growth rate and profit margin should sum to at least 40 per cent. McKinsey research finds that barely one-third of software companies achieve this benchmark, yet investors consistently reward those who do with higher enterprise value to revenue multiples.
The formula is straightforward: Rule of 40 Score = Annual Revenue Growth Rate (%) + EBITDA Margin (%)
- Scenario A (High Growth): A company growing at 50 per cent year-on-year with a -10 per cent EBITDA margin scores a 40. Buyers accept the cash burn because the growth captures market share.
- Scenario B (Cash Cow): A company growing at 10 per cent with a 30 per cent EBITDA margin also scores a 40. Buyers value the immediate cash generation.
- Scenario C (The Dead Zone): A company growing at 15 per cent with a 10 per cent margin scores a 25. This business is failing the Rule of 40. It is growing too slowly to be exciting but is not profitable enough to be safe.
Buyers use this heuristic to categorise your business. If you are in the "Dead Zone," you will struggle to attract premium offers. Before selling, you must pick a lane: either accelerate growth by investing aggressively or cut costs to maximise profitability. Trying to do both halfway often pleases no one.
Integration Complexity and Technical Debt
Finally, buyers think about the "morning after." Once the deal is signed, they have to integrate your systems, culture, and data with their own.
Complexity is a value destroyer. If your technology stack is built on obsolete frameworks, or if your code base is "spaghetti code" that only your founding engineer understands, the buyer has to budget for a complete rebuild.
This concept is often called "Technical Debt." In M&A, technical debt is treated like financial debt. McKinsey estimates that technical debt amounts to 20 to 40 per cent of the value of a company's entire technology estate. Companies routinely pay an additional 10 to 20 per cent on any project to address legacy issues. The cost to fix it is often deducted from the enterprise value, sometimes substantially.
Buyers will conduct a code audit. They look for:
- Standardised, modern tech stacks (e.g., AWS, React, Python) rather than obscure, custom languages.
- Clean IP ownership records.
- Documented APIs and data structures.
If a buyer sees a "black box" that they cannot easily maintain or integrate, they will perceive a high risk of operational failure. They may walk away entirely or significantly reduce the offer to account for the engineering resources required to stabilise the asset.
Transferring Confidence
Selling a business is the process of transferring confidence. You are asking a buyer to believe that your past performance is a reliable indicator of their future returns.
The founders who achieve the best exits are those who understand this mindset early. They stop viewing their business as a personal project and start managing it as an investment product. They focus on NRR to prove retention. They build management teams to reduce key person risk. They balance growth and profit to satisfy the Rule of 40.
By viewing your company through the buyer's eyes, you move from a defensive position to one of strength. You are no longer just selling a company; you are offering a de-risked, high-quality asset that commands a premium in the market.
For founders who want a second opinion on positioning or timing, we are always happy to have an initial conversation. Get in touch with our team.