A buyer I was working with had a deal that looked clean on paper.
$884,000 purchase price. 2.6x on $340,000 of SDE. An auto repair shop with steady repeat work, seven techs on staff, and no single customer over 5% of revenue.
Then his CPA asked one question during due diligence that changed the math:
“How many of these seven get a W-2?”
Three. The other four were paid as 1099 contractors.
Why That Question Mattered
The four techs paid as 1099s showed up on a set schedule, used the shop’s lifts and diagnostic equipment, took work assignments from the service manager, and had done so for years.
Under the IRS’s common-law test for worker classification, that’s not what an independent contractor relationship looks like. Behavioral control, tools furnished by the business, and an ongoing relationship all point toward employee, not contractor.
The seller wasn’t trying to defraud anyone. He’d paid techs this way since he opened the shop, other shops in the area did the same thing, and nobody had ever flagged it.
That’s not a defense. It’s just how the exposure builds quietly for years without anyone noticing.
The Department of Labor’s classification rulemaking has shifted twice in the last few years depending on the administration in office, which tells you something on its own: this isn’t settled ground, and “everyone in the industry does it this way” isn’t a defense that ages well.
What Reclassifying Them Actually Costs
Here’s where it stopped being a compliance footnote and became a pricing problem.
The four 1099 techs were paid $52,000 a year each — $208,000 total.
Paid as W-2 employees instead, the shop would owe the employer side of FICA (7.65%), FUTA/SUTA, and workers’ comp premiums it wasn’t carrying on those four at all. Roughly 12% of $208,000.
That’s about $25,000 a year in real payroll cost the seller’s SDE was never absorbing.
Recast the SDE with that cost built in and $340,000 becomes $315,000.
Same business. Same revenue. Same customers. Just a $25,000-a-year expense the reported number was quietly missing.
The Multiple You Actually Paid
This is the part most buyers never do the math on.
$884,000 divided by the seller’s $340,000 SDE is 2.6x. That’s the number on the LOI.
$884,000 divided by the corrected $315,000 SDE is 2.81x. That’s the number the buyer was actually paying, whether he did the math or not.
Nobody renegotiated the price. The seller’s number just didn’t hold up once you looked at what running the business legally would actually cost.
And the buyer wasn’t inheriting a clean start — he was inheriting the same four techs, under the same arrangement, with a decision to make on day one: keep paying them as 1099s and take on fresh misclassification exposure of his own starting at closing, or fix it immediately and eat the $25,000 a year the seller never had to.
Either way, the $884,000 price was built on a number that assumed the second option didn’t exist.
How This Gets Fixed Before Closing, Not After
The mistake most buyers make here is treating this as a legal detail for the closing attorney instead of a pricing detail for the LOI.
Once the classification issue is on the table, there are really only two honest paths.
Renegotiate the price using the corrected $315,000 SDE, so the multiple you agreed to actually reflects what the business costs to run compliantly. On this deal, that’s the difference between $884,000 and roughly $819,000 at the same 2.6x.
Or keep the price and build in a transition plan — reclassify the four techs to W-2 in the first 90 days, budget for the added $25,000 a year going in, and treat the discount you didn’t get on price as the cost of a smoother handoff with existing staff.
There’s a third piece worth flagging separately from price: if the deal is structured as a stock purchase rather than an asset purchase, the buyer can also inherit the seller’s historical exposure — three years of unpaid employer payroll tax on those four techs, plus penalties, if the IRS or DOL ever looks backward. That’s a conversation for an escrow holdback or seller indemnification, not something to skip because the deal otherwise looks clean.
What you don’t get to do is close on the seller’s SDE, keep the workers classified exactly as they were, and assume nothing changes. That’s the version of this deal that turns into a problem eighteen months from now instead of ninety days from now.
The Takeaway
Reported SDE reflects how the seller ran the business, not how you’re required to run it.
If a target has workers paid as 1099s who function like employees — set schedules, company tools, ongoing assignments — get your CPA to run them through the classification test before you finalize price, not after you own the problem.
Recast the SDE assuming full compliance. Negotiate off that number, not the seller’s.
A $25,000-a-year gap doesn’t sound like much until you multiply it by the deal multiple and realize it was never really available to you in the first place.