Why it matters
You are buying what the business will earn after you own it, not what it earned before. When revenue or profit is falling, the latest 12 months are a better guide than a three-year average, and the next 12 may be lower again. Listings tend to lead with the strongest year, or with an average that softens the trend.
A fall in revenue rarely stays a fall in revenue. Rent, salaries, insurance and software cost the same whether sales rise or fall, so profit drops faster. Take a fictional plumbing firm, Quillon Plumbing, with revenue of $1,000,000, a gross margin of 50% and $300,000 of fixed costs, leaving $200,000 of profit. If revenue falls 10% to $900,000, gross profit falls by $50,000 and profit falls to $150,000: a drop of 25%.
A decline also shrinks what you can borrow. Lenders usually size loans on recent earnings, so a falling trend tends to mean a larger deposit or more seller finance.
Loupe's valuation tool compares the last 12 months of revenue with the 12 months before. At its starting settings, a fall of 5% to 20% reduces the multiple by 10%, and a fall of more than 20% reduces it by 20%. For SaaS, annual growth replaces this rule, and negative growth takes 15% off. The result is indicative. A decline with a clear cause that has already ended is a different risk from one nobody can explain.
Gross margin is revenue minus the direct cost of what a business sells, shown as a percentage of revenue. It shows how much each sale contributes towards overheads and profit.
Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.
How to spot it
Ask for revenue and profit by month for at least the last 24 months. Compare each month with the same month a year earlier, so seasonal swings do not mislead you, and see whether the gap is narrowing or widening.
Signs to look for:
- The listing quotes an average of several years, or a figure with no date range.
- The last 12 months are weaker than the last full financial year.
- Gross margin is slipping while revenue holds steady, which often points to price cuts or rising input costs.
- Revenue is flat, but the number of customers, orders or active subscribers is falling.
- Marketing spend is rising just to keep revenue level.
- The seller blames a one-time event but cannot show when it started or that it has ended.
Questions to ask the seller
- What were revenue and profit in each of the last 24 to 36 months?
- Which customers, products, locations or channels account for the fall?
- What caused it, and is that cause over or still affecting the business?
- What have you tried to reverse it, and what happened?
- How do the figures for this year to date compare with the same months last year?
- Did the trend play any part in your decision to sell?
Documents to request
- Monthly profit and loss statements for the last 24 to 36 months
- Filed accounts (financial statements) and tax returns for the last three years
- Revenue by customer, product and channel for the same period
- Management accounts for the current year, with the same months of the prior year alongside
- Bank statements for the last 12 months, to confirm recent revenue
- Any budget or forecast the seller has prepared, with its assumptions