Across East Africa, demonstrably profitable businesses routinely sell for a fraction of what their earnings would suggest — or fail to sell at all. Founders tend to attribute this to the market, the sector or the economy. It is rarely any of those. It is informality, and unlike the economy it is something the founder controls.
This article explains what the informality discount is, the specific mechanisms by which it is applied, why it bites harder in our region than elsewhere, and why the arithmetic of staying informal is worse than it looks.
What the discount actually is
When a buyer cannot verify earnings, they do not estimate them conservatively. They exclude them. Value is then calculated on what remains: assets, bank-evidenced cash flows, audited profit.
The exclusion shows up in five forms, and most founders only notice the first:
A lower valuation multiple
A larger share of the price deferred into earn-outs
Larger escrows and retentions held back after completion
Broader warranties and indemnities, exposing the seller to post-completion claims
Or, most commonly, no transaction at all
That last outcome is the one the statistics never capture. Deals that never reach a term sheet leave no record, so founders see only the businesses that sold and conclude the market is thin. The market is not thin. The supply of transactable businesses is.
Where the discount comes from
Unbanked or partially banked revenue. Cash sales that do not appear in bank records cannot be relied upon by anyone who must justify the purchase to a credit committee or an investment committee.
Mixed personal and business expenditure. Buyers normalise earnings by stripping out what a new owner would not incur. Where personal and business spending are intermingled and undocumented, they cannot perform that separation — so they assume the unfavourable version.
Tax non-compliance. Unfiled returns or live disputes with KRA, URA, TRA, RRA or the Ethiopian Ministry of Revenues become the buyer's liability after completion. The response is a price reduction, a specific indemnity, or both.
Undocumented commercial relationships. Verbal supply and customer arrangements may not survive a change of ownership, and a buyer has no way to test whether they will.
Unclear ownership. Informal partners, family claims, undocumented historic share transfers. This category does not produce a discount so much as a dead stop, because no buyer can acquire what cannot be shown to be owned.
Weak controls. Without reconciliations and approval processes, buyers price the possibility of leakage, fraud or simple misstatement — risks they cannot size and therefore price pessimistically.
A worked illustration
A Kampala FMCG distributor claims annual EBITDA of UGX 2 billion.
Financial due diligence finds:
UGX 1.4 billion supported by bank statements and audited accounts
UGX 400 million from cash sales with no independent evidence
UGX 200 million of costs missing from the accounts because the founder paid some suppliers personally
Verified, normalised EBITDA: UGX 1.2 billion. The buyer also identifies two years of unfiled VAT returns and applies a lower multiple to reflect the tax risk.
Against the founder's expectation of five times UGX 2 billion — UGX 10 billion — the offer is four times UGX 1.2 billion, or UGX 4.8 billion, with UGX 1 billion held in escrow against the tax exposure.
The business did not change between the founder's expectation and the buyer's offer. What changed is that one of them had to prove the numbers. Note also the compounding: the unverified revenue reduced the base, and the tax exposure reduced the multiple, and the escrow reduced the cash at completion. Three separate deductions from one underlying cause.
The figures are illustrative; the structure of the loss is typical.
Why the discount is larger in East Africa
Markets with deep private-deal data allow buyers to calibrate. If a sector trades at a known range, a buyer with imperfect information about one target can anchor on what comparable businesses fetched.
East Africa publishes almost no private-deal data. Buyers therefore rely far more heavily on the quality of each individual target's information, because there is nothing else to triangulate against. The penalty for poor information is correspondingly higher — and, symmetrically, the premium for good information is higher too.
This produces an outcome worth sitting with: a formal, well-documented East African business is a scarce asset. It can command a premium relative to its peers that the same business would not command in a market where documentation is unremarkable.
Development-finance institutions and private equity funds operating in the region compound the effect. Their compliance requirements are not negotiable. They cannot invest in businesses with unresolved tax or governance issues regardless of how attractive the commercial case is — which removes a large tranche of the available capital from informal businesses entirely.
The arithmetic founders get wrong
The usual objection to formalising is that it means paying more tax. That is often true in the short term, and it is the wrong comparison.
Formalising increases annual tax payments by some amount. It increases the value of the business at exit by a multiple of the verified earnings base — so a shilling of profit moved from unverifiable to verifiable is worth a shilling of extra tax now against several shillings of additional sale value later. It also unlocks bank credit at better rates, access to larger customers, and eligibility for government and corporate tenders, each of which compounds in the intervening years.
For most growing businesses the trade is not close. The reason founders resist anyway is that the tax cost is immediate and certain while the valuation benefit is deferred and uncertain — which is a behavioural problem rather than a financial one.
The past is a separate question from the present
Many businesses carry historic informality they cannot retroactively correct. Buyers understand this; it is not disqualifying on its own.
What buyers need is a clean line: honest disclosure of what happened historically, evidence that compliance is now genuinely in place, and a defensible position on any material exposure. Several revenue authorities in the region have operated amnesty or voluntary disclosure programmes, and whether regularising a past position is advantageous depends entirely on the size of the exposure, the limitation periods and the likelihood of detection.
That is a judgement call with real downside in both directions, and it is not one to make from general principles.
A self-test
Could you provide a buyer, within one week, with three years of bank statements that reconcile to your accounts, a current tax compliance certificate, and signed contracts with your top ten customers?
If the answer is no, you are carrying an informality discount today — whether or not anyone has quoted you a number.
The questions that decide the size of your discount
What proportion of your reported earnings could be independently verified from bank records alone?
Which of your costs would a buyer be unable to classify as personal or business, and what would they assume?
What is your actual exposure across each tax head, and have you ever quantified it rather than estimated it?
Which of your key commercial relationships exist only verbally, and what would a change of ownership do to them?
Is your share register complete and consistent with every historic transfer?
Given your exposure, is voluntary disclosure or regularisation advantageous — or does it create risk that would otherwise stay dormant?
Where founders need guidance
Closing the gap is a sequencing problem more than a knowledge problem. Most founders know in outline what formality requires. What they cannot easily judge is the order, the cost, which exposures to address and which to disclose, and how long it takes before the work actually changes what a buyer will pay.
Acquihub works with East African founders on exactly this: assessing where the discount is being applied, independent valuation to benchmark the starting point, and building the business toward the standard that buyers and institutional capital require. If you want to know how investable your business is today and what the discount is costing you, talk to us.
Frequently asked questions
What is the informality discount? The reduction in value a buyer applies when earnings cannot be independently verified. Rather than estimating unverifiable profit conservatively, buyers typically exclude it and value the business on what can be proven.
How much does informality reduce a business's value? It varies, but the loss compounds through several channels at once: a smaller verified earnings base, a lower multiple applied to it, and more of the price deferred into escrow or earn-outs. The combined effect frequently exceeds half the founder's expectation.
Isn't formalising just paying more tax? It usually does increase annual tax. It also raises the verified earnings base that a multiple is applied to at exit, so the valuation gain is typically several times the additional tax, alongside better credit access and eligibility for larger customers and tenders.
Can I fix historic informality before selling? Past records cannot be retroactively created, but buyers do not require a perfect history. They require honest disclosure, evidence that compliance is now in place, and a defensible position on material exposures. Whether to regularise a historic position through voluntary disclosure depends on the specific exposure.
How long does it take to remove the discount? Establishing a verified earnings track record takes years rather than months, because the evidence is historic by definition — a buyer wants to see several periods, not a recent improvement.