Our revenue is growing at 25 percent annually, but our gross margins have compressed from 48 percent to 41 percent due to rapid hiring and expedited shipping. Will buyers reward our top-line expansion or penalize our compressed margins when setting our enterprise value multiple?

Question

Tyler Smith · Accepted Answer

Buyers will penalize compressed gross margins almost every time. Top-line revenue growth is attractive, but gross margin is the purest indicator of your operational efficiency, pricing power, and business moat. When gross margin drops seven hundred basis points, buyers interpret it as unmanaged operational friction, poor quality of control, or commoditization of your offering.

In lower-middle-market M&A, buyers pay premium multiples for durable, high-margin cash flow. A company generating $10 million in revenue at a 48 percent gross margin with 15 percent growth is far more valuable than a company generating $15 million in revenue at 41 percent gross margin with 25 percent growth. The first company requires less capital to scale and demonstrates pricing leverage.

If your gross margin compression is the result of temporary operational scaling, such as onboarding new capacity, training operational seats on the Accountability Chart, or temporary supply chain surcharges, you must isolate those costs during sell-side preparation. Do not let buy-side diligence classify structural margin degradation as standard performance.

Use your quarterly Rocks to fix operational delivery before going to market. Optimize scheduling, automate labor-intensive handoffs using targeted AI workflows, and eliminate expedite shipping fees through tighter inventory forecasting on your Scorecard.

If you enter diligence with declining gross margins, buyers will use your 41 percent floor to calculate their go-forward earnings model, shaving at least one to two turns off your enterprise multiple. Stabilizing gross margins back toward historical levels before launching your process will deliver significantly more net proceeds than chasing unprofitable revenue growth.