Most owners value their business one of two wrong ways: on revenue, or on what they need to retire. Buyers value it on earnings and risk. This guide walks through how a small business is actually valued for sale so you can arrive at a number a buyer would recognize, and understand what would change it.
This is an owner's working method, not a formal appraisal. For tax, legal, divorce, or financing purposes you need a credentialed valuation.
Start with the right earnings number
Seller's discretionary earnings (SDE)
For owner-operated businesses, usually under $1 million to $2 million in profit, the standard measure is SDE: the total financial benefit one owner-operator gets from the business in a year. Start with net profit and add back:
- Owner's salary and payroll taxes (one owner)
- Owner's benefits: health insurance, vehicle, phone, retirement contributions
- Depreciation and amortization
- Interest
- One-time or non-recurring expenses (a lawsuit, a flood, a one-off equipment repair)
- Personal expenses run through the business
Be honest about add-backs. Buyers and their lenders will test every one. An add-back you cannot document is a credibility problem that costs more than the add-back was worth.
EBITDA
For companies with a management team where the owner is not doing a full-time job, buyers use EBITDA: earnings before interest, taxes, depreciation, and amortization, with a market-rate salary for a general manager deducted. EBITDA is lower than SDE for the same business because it pays someone to do the owner's job. Multiples on EBITDA are higher than on SDE, which partly offsets this.
Which measure applies to you is mostly a function of size and whether the business runs without you. The line is roughly $1 million to $2 million in earnings and a real management layer.
Apply a multiple
Value equals earnings times a multiple. The multiple is where the market's view of risk and growth shows up.
Broad ranges for small businesses in the United States, as a starting point only:
- SDE multiples: roughly 1.5x to 3.5x for most main-street businesses. Service and trade businesses heavily dependent on the owner sit at the low end; businesses with repeat revenue, a team, and growth sit at the high end.
- EBITDA multiples: roughly 3x to 6x for lower middle-market companies, rising with size, growth, and recurring revenue.
Industry matters, and so does the year. Databases of actual sold-business transactions (brokers and valuation professionals subscribe to them) give the real range for your industry and size. A broker who knows your industry can usually tell you the range in one conversation.
What moves the multiple
Two businesses with identical earnings can sell for very different prices. These are the factors that move the multiple most:
Pushes it up
- Recurring or contracted revenue: service agreements, subscriptions, maintenance contracts
- A management team that runs the week without the owner
- Diversified customers, with no single account above 10 to 15 percent of revenue
- Three or more years of clean, consistent, outside-reviewed financials
- Documented systems and processes
- Steady growth and a believable reason it continues
- A long lease or owned real estate (often sold separately)
- Licenses, certifications, or relationships that are hard to replicate
Pushes it down
- Owner dependence: the owner is the top salesperson, the key technician, or the only one customers know
- Customer concentration
- Declining or erratic earnings
- Messy books, cash sales, or large unexplained add-backs
- Deferred maintenance on equipment or facilities
- Key employees who could leave and take business with them
- Pending legal, tax, or regulatory problems
A worked example
A plumbing contractor does $2.4 million in revenue. Net profit on the tax return is $180,000. The owner pays himself $120,000, runs a $14,000 truck and $9,000 of health insurance through the company, and has $35,000 of depreciation and $6,000 of interest. There was a one-time $16,000 legal expense this year.
SDE = 180,000 + 120,000 + 14,000 + 9,000 + 35,000 + 6,000 + 16,000 = $380,000.
If the owner still runs every estimate and the top three customers are 45 percent of revenue, a buyer might apply 2.0x to 2.3x: a value around $760,000 to $875,000, plus or minus inventory and working capital.
If instead there is an operations manager running the schedule, 30 percent of revenue is on service agreements, and no customer is over 10 percent, the same earnings might support 2.8x to 3.2x: $1.06 million to $1.22 million.
Same business, same earnings, roughly $300,000 to $350,000 difference. That gap is the return on the preparation work.
What the value does not include
Most small-business values are quoted for the operating business and its fixed assets, with the buyer taking over a normal level of working capital. Real estate is usually valued and sold separately. Cash, and often receivables, stay with the seller. Debt is paid off at closing from the proceeds. Make sure every conversation about price is clear on what is included.
Getting a real number
Three ways, in order of cost:
- Do the SDE math yourself with the method above and a conservative multiple. Good for a first read.
- Ask a broker for a broker's opinion of value. Often free or low cost, usually tied to the hope of a listing. Useful for the industry range.
- Hire a credentialed appraiser for a formal valuation when the number has legal or tax consequences.
Our Exit Readiness Review gives an operator's value range together with the specific list of what is discounting it, so you can change the number rather than just learn it.
Common questions
What is the difference between SDE and EBITDA?
SDE adds back one owner's full compensation and benefits, because it measures what an owner-operator takes home. EBITDA deducts a market-rate salary for a manager and is used when the business runs with a management team. SDE is higher for the same business; EBITDA multiples are higher to partly compensate.
What is a typical multiple for a small business?
For most main-street and trade businesses valued on SDE, roughly 1.5x to 3.5x. For larger companies valued on EBITDA, roughly 3x to 6x. Industry, size, growth, recurring revenue, and owner dependence set where a specific business lands.
Is a business worth a multiple of revenue?
Rarely. Revenue multiples are used as a rough cross-check in a few industries, but buyers pay for earnings. Two businesses with the same revenue and different margins are worth very different amounts.
Does the value include inventory and real estate?
Usually the quoted value covers the operating business and fixed assets with normal working capital. Inventory is often added at cost, real estate is valued separately, and cash and debt are settled at closing.