How dependence on the owner affects business value outside healthcare

The short answer, explained

When a buyer acquires a business, it is paying for earnings that will continue under new ownership. In many trades, consulting and service businesses, a large share of those earnings arrives because of the owner personally: clients ring the owner, the owner prices every job, the owner holds the technical judgement, or the owner's name is the brand.

The ATO's ruling on goodwill, TR 1999/16, draws the line clearly. The part of goodwill that comes from an owner's personality, reputation, skills or attributes is not transferable. Other sources of goodwill, such as the habit or inertia of customers, continue to draw custom after the owner leaves, and that goodwill can be sold. Valuing an owner-dependent business is largely a question of how much of the earnings falls on each side of that line.

Healthcare practices have their own version of this problem, which Medival covers in how practitioner dependence affects business value. This page is for other businesses.

How a valuer reflects dependence

The first step matters more than owners expect. If the owner works for less than the market cost of their roles, the earnings are overstated before dependence is considered at all. Once a market salary is deducted, the remaining question is whether clients and know-how will stay with a new owner who pays someone else to do the work.

Market value assumes a hypothetical willing buyer, not a particular buyer. A competitor who already knows the clients might pay more, but the valuation asks what earnings would transfer to buyers generally. Oliver Group, the Valuo practice for restructures, tax and buyouts, discusses the wider risk in key person risk and business value and the split between personal and business goodwill in personal vs transferable goodwill.

The owner dependence scorecard

Score each item 0, 1 or 2. The scorecard is a way to find where the dependence sits and what to fix first. It is not a pricing formula, and it does not convert into a discount.

Items scored 2 are where to act first. A business with several 2s should expect a buyer, and a valuer, to question how much of the earnings would continue.

Worked example: a hypothetical electrical contractor

This example is hypothetical. The attrition rates, the contribution margin and the 3.0 multiple are assumptions chosen for the arithmetic, not market evidence.

The business has revenue of $2,000,000 and normalised earnings of $400,000 after paying the owner a market salary for the roles they perform. Clients who deal only with the owner provide 40% of revenue, or $800,000.

Without a transition plan, the valuer assumes a quarter of that owner-only revenue would not stay with a new owner, and that each dollar of lost revenue would cost 30 cents of earnings (the contribution after the direct costs that would also fall away).

Check: 40% x $2,000,000 = $800,000. $800,000 x 25% = $200,000. $200,000 x 30% = $60,000. $400,000 - $60,000 = $340,000.

Now suppose the owner spends a year moving those clients to a project manager, documenting quoting and sign-off, and introducing clients to the team. The valuer's attrition assumption falls to 10%: $800,000 x 10% = $80,000 of revenue, x 30% = $24,000 of earnings, leaving $376,000.

Check: $400,000 x 3.0 = $1,200,000; $340,000 x 3.0 = $1,020,000; $376,000 x 3.0 = $1,128,000. $1,128,000 - $1,020,000 = $108,000.

Keeping the multiple fixed isolates the earnings effect. A valuer could instead reflect the same risk in a lower multiple; doing both for the same risk would count it twice. The capitalised earnings sensitivity tool lets you test both levers.

Steps that reduce dependence

• Move relationships. Introduce a second contact for every major client, and have staff lead the work while you are still there to back them up.
• Hand over pricing. Write down how jobs are quoted and let a senior employee quote within limits.
• Document the work. business.gov.au's succession planning guidance recommends writing down policies, procedures and processes so that vital knowledge does not leave with the owner.
• Put things in the business's name. Contracts, accounts, the website, phone numbers and reviews.
• Build a second tier. A manager or senior tradesperson who can run the day-to-day.
• Plan the exit terms. business.gov.au notes that a sale is negotiated with handover training and staff arrangements, and that the contract can include restraint clauses such as non-compete terms. A handover protects the transfer; it does not replace the steps above.

Limitations

• This page describes valuation practice and cites TR 1999/16 for the concept of personal and business goodwill. TR 1999/16 is a tax ruling about CGT and goodwill; it does not set valuation discounts.
• Whether a restraint of trade is enforceable depends on its terms and the law that applies. That is a question for a lawyer.
• The worked example uses fixed assumptions to show the mechanics. Real attrition depends on the clients, the industry and the buyer's own team.
• In family law matters, the treatment of goodwill that depends on a party can raise further issues; Family Law Valuations covers them in goodwill and owner dependence in family law business valuations.

Next steps

• Score your business on the scorecard and list the 2s.
• Work out what share of revenue comes from clients who deal only with you.
• Calculate the market cost of your roles using the earnings normalisation worksheet.
• If a sale is a year or more away, start the transition steps now; see preparing for buyer due diligence.

General educational information, not financial, tax or legal advice. Worked examples are hypothetical and do not value a real business. A valuation depends on its purpose, the evidence and the agreed scope.