What a Declining Business Is Worth?
Declining, How Do You Determine What the Business Is Worth?
Why yesterday’s profits may not reflect tomorrow’s business value
By Legacy Venture Group | Business Sales, Valuations & Exit Planning
Imagine you’ve owned a successful business for 20 years. You’ve worked hard, built a loyal customer base, established a reputation in your industry, and enjoyed the financial rewards of business ownership.
But over the last two or three years, something has changed.
Revenue has been declining. Profitability has weakened. Perhaps competition has intensified, customer buying habits have shifted, or the industry itself is experiencing a slowdown.
You may still have a good business. But is it worth what it was three years ago?
And more importantly, how should a business valuation account for declining revenues and Seller’s Discretionary Earnings (SDE)?
These questions become particularly important when preparing a business for sale, considering an acquisition offer, or determining a company’s current market value.
The Problem with Looking in the Rearview Mirror
One commonly used method of valuing privately held businesses involves examining the past three to five years of financial performance.
Business brokers and valuation professionals often calculate Seller’s Discretionary Earnings (SDE), which generally represents the financial benefit available to a full-time owner-operator before certain expenses, including one owner’s compensation, interest, depreciation, amortization, and appropriate discretionary or nonrecurring expenses.
For many small businesses, SDE is an important measurement because buyers want to understand the financial benefits associated with ownership.
Valuation professionals may calculate a weighted average of historical earnings, assigning more weight to recent years.
This approach can work well when revenues and earnings are relatively stable or when fluctuations are temporary.
But what happens when earnings have been declining consistently for 24 to 36 months?
A historical weighted average may make a deteriorating business appear more profitable than it is likely to be in the future.
And that’s where valuation professionals need to exercise judgment.
An Example: Three Years of Declining Earnings
Consider a privately held business with the following financial performance:
| Year | Annual Revenue | SDE |
|---|---|---|
| 2023 | $3,000,000 | $500,000 |
| 2024 | $2,600,000 | $400,000 |
| 2025 | $2,200,000 | $300,000 |
| Next 12 Months (Projected) | $1,900,000 | $240,000 |
Over three historical years, revenues have fallen substantially, and discretionary earnings have declined by 40%.
A traditional weighted average might assign a weight of one to 2023, two to 2024, and three to 2025.
That calculation produces weighted-average SDE of approximately $367,000.
However, if current conditions indicate that the business may generate only $240,000 in SDE during the next 12 months, we have a significant difference.
Now suppose comparable business sales suggest that a multiple of 2.5 times SDE could be appropriate, before accounting for specific business risks.
Using the historical weighted average:
$367,000 × 2.5 = approximately $917,500
Using anticipated future earnings:
$240,000 × 2.5 = $600,000
That’s a difference of more than $300,000.
These are illustrative calculations, and the appropriate valuation multiple may differ depending on whether historical or projected earnings are being used.
Nevertheless, the example demonstrates why selecting the proper earnings figure is so important.
A buyer is not purchasing the opportunity to earn what the seller earned three years ago.
A buyer is purchasing the opportunity to generate future earnings.
What Does NACVA Say About Historical Versus Future Earnings?
The National Association of Certified Valuators and Analysts (NACVA), one of the leading professional organizations providing education, credentials, and standards for business valuation professionals, recognizes that different approaches may be appropriate when estimating a company’s ongoing earnings capacity.
NACVA’s educational materials discuss the use of historical averages, weighted averages, trend analysis, and projected economic income.
A central principle is that the earnings selected for valuation should reasonably represent the economic benefits expected from the business.
Historical financial results are critically important. They provide evidence of the company’s demonstrated performance, profitability, and operating history.
However, when those historical results no longer represent the company’s likely future performance, adjustments or alternative methods may be appropriate.
For example, a company experiencing a temporary earnings decline because of a short-lived disruption may reasonably be valued differently from one operating in an industry experiencing long-term structural deterioration.
The objective is not simply to select the most favorable historical earnings figure. It is to identify a defensible measure of ongoing earning capacity.
NACVA’s Professional Standards also identify earning capacity, economic conditions, and industry outlook among the considerations relevant to a business valuation.
These standards do not mandate a particular three-year weighted average or automatically require a 12-month forecast. They support selecting and documenting methods appropriate to the circumstances.
Not All Declining Businesses Are the Same
When evaluating a company with deteriorating financial results, we believe it is essential to understand why the decline is occurring.
Consider three different scenarios.
Scenario One: A Temporary Decline
A business loses a key employee, experiences a temporary supply chain disruption, or faces a short-term operational problem.
Revenue and profits decline, but the company retains its customers, competitive advantages, and underlying market demand.
If management has addressed the problem and there is credible evidence of recovery, historical earnings may remain relevant.
In this situation, a weighted average or adjusted earnings calculation may reasonably capture the company’s ongoing economic potential.
Scenario Two: A Business in an Eroding Market
Imagine a company serving an industry where demand has steadily declined because of technology, changing consumer behavior, consolidation, or new competitors.
Its sales have dropped for three consecutive years.
Its customer base is shrinking, and there is little evidence of an immediate turnaround.
In this situation, using earnings from stronger historical years may substantially overstate current earning capacity.
A more appropriate approach may be to examine recent results and develop a supportable forecast of what the business is likely to generate over the next 12 months or longer.
If future earnings are expected to continue changing significantly, a multiyear forecast and discounted cash flow analysis may be more appropriate than capitalizing a single earnings figure.
Scenario Three: Declining Revenue but Stabilizing Profitability
Now consider a company whose revenues have declined, but whose management team has reduced overhead, improved efficiencies, eliminated unprofitable product lines, and strengthened gross margins.
Although sales are falling, discretionary earnings may have stabilized.
In this case, projecting continued declines based solely on historical revenue trends may be unnecessarily pessimistic.
This illustrates another important point:
Valuation is not just about calculating numbers. It is about understanding the business behind those numbers.
Five Questions Every Business Owner Should Ask
If your company has experienced declining revenues or earnings over the last two or three years, here are five questions worth considering before establishing an asking price.
- Is the decline temporary or permanent? Understanding whether the business is experiencing a short-term setback or a long-term market change is fundamental to determining value.
- What do the most recent financial results tell us? The last 12 months, and sometimes the most recent three to six months, may provide important insights into the company’s present direction. Seasonality must also be considered.
- What earnings can a new owner reasonably expect? Buyers will examine customer retention, contracts, employee costs, market trends, and likely operating expenses to determine sustainable earnings.
- Are there opportunities to reverse the decline? New products, improved marketing, operational changes, or market expansion may provide opportunities for recovery. However, potential improvements are not necessarily equivalent to demonstrated earnings.
- Does the valuation multiple adequately reflect risk? Two businesses producing identical earnings may have very different values if one is growing and the other is declining. The multiple must also be appropriate for the earnings basis being used, without counting the same risks twice.
Why Pricing a Declining Business Too High Can Be Costly
Business owners naturally have an emotional and financial attachment to the companies they have built.
After 15, 20, or 30 years of ownership, it can be difficult to accept that the business may not command the same valuation it would have received several years earlier.
We understand that.
But establishing an asking price based on financial performance that is no longer sustainable can create serious challenges.
Qualified buyers may hesitate to make offers. Financing can become more difficult. Due diligence may reveal declining trends that were not adequately reflected in the asking price.
And the longer a deteriorating business remains on the market, the greater the possibility that its earnings—and value—will decline further.
The objective should never be to artificially inflate or unnecessarily discount the company’s value.
The objective is to arrive at a credible, market-supported valuation that gives the owner the best opportunity to achieve a successful sale.
The Importance of Looking Forward
At Legacy Venture Group, we have been helping business owners understand value, prepare for transitions, and confidentially sell their businesses since 2004.
One of the most important lessons from that experience is that financial statements tell only part of the story.
Numbers reveal what has happened.
Understanding operations, customer relationships, market conditions, management capabilities, and future opportunities helps us evaluate what may happen next.
When a company is experiencing declining revenues and earnings, that distinction is especially important.
A knowledgeable business intermediary or valuation professional should be able to explain not only the earnings figure selected, but why that figure is the most reasonable basis for estimating value.
A weighted average may be appropriate. The most recent 12 months may be more representative. Or a carefully supported projection may provide the strongest indication of future economic benefit.
No single calculation is right for every business.
Don’t Wait Until the Decline Becomes a Crisis
Perhaps the most important message for business owners is that declining earnings should be addressed early.
If your business has experienced 24 to 36 months of declining performance, this may be an ideal time to obtain a professional assessment of its value and explore opportunities to improve its marketability.
You may discover that the business still has considerable transferable value.
You may identify operational improvements that could help restore profitability.
Or you may determine that selling sooner, rather than waiting for further deterioration, is the most sensible course of action.
A professional assessment can help you make those decisions with greater clarity.
At Legacy Venture Group, our philosophy is simple:
Start with the Heart. Strengthen the Legacy. Amplify the Value. Go for the Gold. Embrace the Freedom.
Our goal is to help business owners obtain the best possible price, find the right buyer, and enjoy the peace of mind that comes from knowing their legacy can continue.
Wondering What Your Business Is Worth Today?
Whether your company is growing, holding steady, or experiencing declining performance, understanding its current market value is an essential part of sound business planning.
We welcome the opportunity to have a confidential conversation about your business, its financial performance, and the opportunities available to you.
Legacy Venture Group — Business Sales and Valuations
Helping Business Owners Maximize Value, Navigate Transitions, and Build Better Legacies.
Professional References
National Association of Certified Valuators and Analysts (NACVA)
- NACVA Professional Standards, effective June 1, 2023, revised November 22, 2024. Sections addressing economic outlook, earning capacity, valuation methods, and professional judgment.
- Current Update in Valuations (2013), pages 141–144. Discussion of historical versus projected economic income in estimating future economic benefits.
- Business Valuation Experience Requirement Scoring Key (2013). Educational guidance identifying historical averages, weighted averages, static and projected trend lines, and projected earnings growth rates as earnings-capacity analysis methods.
Disclaimer: This article is intended for general educational purposes and does not constitute a formal business valuation, appraisal, financial advice, or a guarantee of a particular selling price. Business valuation conclusions depend on the facts, circumstances, valuation date, applicable standard of value, and selected methodology.