Know What Your Business Is Worth Before You Promise Equity

A range of value is what a business would likely sell for under different conditions: to its management team, to an outside buyer, in a slow market or a hot one. Most owners carry a single number in their heads, usually a rule of thumb, and that number shapes decisions long before any sale. The most expensive of those decisions is often a promise of equity to key people, made against a value the owner never tested.

A Promise Priced at the Wrong Number

Here is a pattern we see often. Key employees come to the owner and ask a fair question: what is in it for us if we keep working this hard to grow the company? They are not asking the owner to sell. They want to know where they fit in the future.

The owner wants to do right by them and offers ten percent.

The owner prices that promise the way many owners do. The business made $1 million last year. Businesses like this sell for about four times EBITDA, so the company is worth around $4 million, and ten percent comes to roughly $400,000. It feels generous and affordable.

Then the market moves. The company's sector, construction work tied to building data centers, becomes one buyers want to own. A buyer shows up talking about eight, nine, even ten times EBITDA. The same ten percent is now worth a couple million dollars. The owner never meant to give that much away.

The owner was working from a number that fit one kind of buyer and ignored the other.

Why One Multiple Is Not Enough

Four times EBITDA is a common benchmark, and it is the right one under specific conditions. It fits a sale to the management team, where financing limits what the buyers can pay. It also fits a business that relies on its owner to produce its profits, because any buyer has to discount for the risk that the earnings leave when the owner does.

An outside buyer looking at a well-run company in a sector with strong demand is pricing something else. In the case above, a realistic range ran from around four times at the low end to eight or ten at the high end. The spread between those numbers is what the owner was giving away without knowing it.

That is why the path comes before the plan. An owner who has decided, with good information, whether the likely buyer is the management team or an outside party can put a sensible value on what they share. An owner who has not decided is guessing.

The range also moves. Buyer interest in a sector can rise or cool over a few years, and the business itself changes as the owner builds a stronger team and reduces its dependence on any one person. A range of value is a snapshot, so it deserves a fresh look before any promise that depends on it, and again as the plan matures.

What a Review Looks at First

When we work through this with an owner, the order matters:

• The business and the owner's goals. What the company does well, where it depends on the owner, and what the owner wants: timing, role, family, and legacy.
• A calculation of value. A range tied to the realistic paths, with the assumptions shown.
• The two main paths. A sale to management, which usually carries a lower multiple because of how those deals are financed, and a third-party sale, where a higher multiple is possible and the dynamics are different.
• The team's role in that path. Once the direction is clear, how the key people participate in reaching it.

The last step is where equity belongs. A plan designed after the owner knows the path can tie awards, payment events, and timing to the outcome everyone is working toward. Our list of questions to answer before designing an equity plan goes deeper on this sequence.

What Happens When There Is No Answer

The opposite mistake is waiting. Key people ask what is in it for them. The owner says they will work something out. Months pass, then a year. Each time the question comes back, the answer gets pushed down the road.

We have seen important people leave companies for that reason alone. They had no certainty about their future and no commitment from the company about a path forward.

A well-built plan answers that question in a way the team can see. It connects their work to the growth in value the owner is building toward, and it gives them a stake in the outcome whether the eventual buyer is the management team or an outside firm. Designed this way, performance equity becomes part of building a business worth more to any buyer, because the people producing the value share in it.

What to Tell Key People in the Meantime

Owners often delay the conversation because they do not have the full answer yet. That instinct is understandable, and silence is still the worst option available. A key person who hears nothing fills the gap with their own assumptions.

Be honest about the sequence instead. Tell them the question is fair and that you are taking it seriously. Explain that you are working out where the business is headed and what it is worth under the paths you are considering, and that a plan for them will follow from that work. Give them a realistic timeframe and keep it.

That conversation shows respect for the people asking and buys the time needed to get the range of value right. It also makes clear that any award will track the path the business is on, instead of a number invented under pressure.

What owners should avoid is a number offered on the spot to relieve the pressure of the moment. A percentage said out loud is hard to take back, even before anything is signed.

Other Numbers That Surprise Owners

The same review that sets a range of value tends to turn up other risks worth fixing early.

Outdated buy-sell agreements. It is common to find a buy-sell agreement with a valuation nobody has checked in years. We have seen the gap between the agreement and reality run to millions of dollars in either direction. Too low, and a family could be shortchanged if something happened to an owner. Too high, and the remaining owners face an obligation they cannot fund. Because the agreement governs what happens after a death or disability, its value and payment terms need to be current and workable. One ownership group told us plainly that if something happened to one partner, they did not think they could complete the buyout, because the payment terms were unclear and the appraisal method left the number anyone's guess.

Estate plans that lag the business. At current multiples in some industries, owners heading toward a third-party sale can find their estate plan no longer fits the value of what they own. Whether that is true for you, and what to do about it, is a question for your estate planning attorney and CPA, and one worth asking early.

Real estate with a low tax basis. One owner we worked with was selling the company to a friendly outside buyer and owned the building the business occupies. The building was worth $2.5 million. Its tax basis was $350,000. That gap meant a gain of more than $2.1 million and a tax bill in the range of $600,000 to $700,000 if the building changed hands at closing.

One alternative on the table was a like-kind exchange into another income-producing property. Whether that option was available, and how to time it, was a question for the owner's CPA and attorney, and it only existed before the sale. Once the building is sold, the clock cannot be unwound.

There are also provisions in the tax code that can reduce or remove federal capital gains tax on certain business sales, for owners whose companies and transactions qualify. Whether any of this applies is a question for your CPA and attorney, and one worth asking years ahead of a sale.

What Owners Catch Before a Promise

Owners sometimes ask whether this kind of work is worth doing if no sale is on the horizon. Avoiding one oversized equity promise can outweigh the cost of the review, whenever the ownership transition happens. The same work often catches an unfunded buy-sell obligation or a tax bill on real estate before either becomes a crisis.

The owner in the first story needed the range and the path before anyone heard a percentage.

If you are fielding questions from key people about their future, our equity compensation resource kit and our approach to performance equity compensation are good places to start.

We discussed this on an episode of our podcast, What Transfers.