How to Value a Business: Methods Explained
The three valuation approaches buyers actually use, how to rebuild earnings before applying a multiple, and how enterprise value becomes the cash a seller receives at closing.
The arithmetic an acquirer performs, in the order they perform it. Rebuilding the earnings, choosing the right earnings measure, selecting a multiple with evidence behind it, and converting enterprise value into money in your account.
How do you value a business?
applying a market multiple to a normalized earnings figure, then adjusting for cash, debt and working capital to reach the proceeds a seller actually receives
. Smaller owner-operated companies are priced on seller's discretionary earnings. Companies with a management team are priced on adjusted EBITDA.
There are three recognized approaches: the income approach, which values future cash flows; the market approach, which prices the company against comparable transactions and listed companies; and the asset approach, which values the balance sheet. In the lower middle market the market approach decides the price in practice, with the income approach used to sense-check it and the asset approach setting a floor for asset-heavy or loss-making companies.
What the multiple prices", value:
The bridge to proceeds", value:
Work in this order. Choosing a multiple before the earnings are rebuilt is the most common mistake owners make, and it produces a number that cannot survive diligence.
Start with the filed numbers, not the management view
Three years of tax returns and financial statements. Anything that does not reconcile to a filed return will be challenged, so the reconciliation is the foundation of everything above it.
Rebuild the earnings: Restate owner compensation to what a replacement manager would cost. Restate related-party rent to market, in both directions. Itemize personal expenses run through the company. Remove genuinely one-off items with documentation behind them. Remove government relief income. Add back nothing you cannot evidence.
Restate owner compensation to what a replacement manager would cost. Restate related-party rent to market, in both directions. Itemize personal expenses run through the company. Remove genuinely one-off items with documentation behind them. Remove government relief income. Add back nothing you cannot evidence.
Choose the right earnings measure
Seller's discretionary earnings adds one full-time owner's compensation back, and suits companies where the buyer will replace the owner personally. Adjusted EBITDA leaves market-rate management cost in, and suits companies a buyer will run with the existing team. Applying an EBITDA multiple to an SDE figure overstates value substantially, and it is a very common error.
Split the revenue before selecting a multiple
Contracted recurring revenue, repeat but uncontracted revenue, and one-off project revenue each deserve a different multiple. A business with sixty percent under written agreements is a different asset from one with the same revenue re-won every January, and pricing it as one blended number costs the seller.
Select the multiple with evidence
Comparable private transactions in the same sub-sector, the trading multiples of listed companies in the sector as a directional check, and the acquisition criteria of the buyers actually active in that market. Each of those is verifiable. A rule of thumb heard at a trade show is not.
Sense-check with a cash flow view
A discounted cash flow model on a lower middle market company is only as good as its assumptions, but it is a useful test of whether the multiple implies a growth rate the business can genuinely deliver. Where the two views diverge sharply, the multiple is usually the optimistic one.
Bridge enterprise value to proceeds
Enterprise value is not what lands in your account. Deduct debt and debt-like items including capital leases, accrued taxes and deferred compensation. Add surplus cash. Apply the working capital adjustment against the agreed target. Then deduct fees and tax. The gap between headline value and net proceeds regularly surprises owners.
What similar companies actually sold for, expressed as a multiple of earnings. The most persuasive evidence in a negotiation, because it reflects what buyers paid rather than what a model predicts. The difficulty is that private transaction data is incomplete, so the comparables need to be genuinely comparable in size, sector and revenue quality.
Market approach: listed company multiples
Publicly traded companies in the same sector publish their numbers every quarter, which makes them a dated, verifiable reference point. Private companies transact at a material discount to them for size, liquidity, concentration and owner dependence, so they set direction rather than price.
Income approach: discounted cash flow
Projects free cash flow and discounts it to a present value. Rigorous in principle and highly sensitive to the discount rate and the terminal value in practice. Most useful where earnings are growing on a trajectory a multiple of last year's profit would understate.
Income approach: capitalization of earnings
A single sustainable earnings figure divided by a capitalization rate. A simpler cousin of discounted cash flow, appropriate for stable companies with little growth, and effectively another way of expressing a multiple.
Asset approach: adjusted net asset value
The balance sheet restated to market value. Sets the floor for asset-heavy companies, holding companies and businesses that do not make money. A profitable service business is almost never valued this way, because its value is in the earnings rather than the equipment.
Rules of thumb: multiples of revenue
Widely quoted and rarely reliable. A revenue multiple implies an assumed margin, and if your margin differs from that assumption the answer is wrong by the size of the difference. Useful only as a sanity check on an earnings-based figure.
Earnings reconciled line by line to filed tax returns
Every add-back supported by a document, not an explanation
Recurring, repeat and project revenue valued separately
Multiples supported by named comparable evidence
Debt-like items identified before the buyer finds them
A working capital target derived from three years of monthly data
The same number presented to every buyer, without adjustment
A multiple applied to reported profit before normalization
An EBITDA multiple applied to a seller's discretionary earnings figure
Add-backs totalling a large share of earnings with thin support
Comparables drawn from companies several times the size
Capital leases and accrued taxes excluded from the debt calculation
A blended multiple applied to a mix of contract and project revenue
A figure built backwards from the amount the owner wants to retire on
The bridge every seller should build before agreeing a headline number. The line items are the ones that appear in a normal lower middle market transaction.
Adjusted earnings: The normalized, evidenced figure
Multiple applied: From comparable evidence, not a rule of thumb
Enterprise value: Earnings multiplied by the multiple
Less debt and debt-like items
Loans, capital leases, accrued taxes, deferred compensation
Plus surplus cash: Cash above the level the business needs to operate
Measured against the agreed target at closing
Less fees and taxes: Advisory, legal, accounting, and tax on the gain
Net proceeds: The figure that actually matters to the seller
Two offers with the same headline value routinely produce net proceeds that differ by a meaningful margin, because of debt definitions, the working capital target, and how much of the consideration is deferred. Compare offers on this bridge rather than on the top line.
What multiple will my business sell for?
It depends on the earnings measure, the sector, and above all the quality of the revenue. The factors that move a multiple within a sector are the proportion of revenue under written, assignable contracts, customer concentration, margin stability, management depth, and whether the business runs without the owner. Two companies in the same trade with the same profit can be valued very differently on those grounds, which is why a sector average is a starting point rather than an answer.
What is the difference between SDE and EBITDA?
Seller's discretionary earnings adds back one working owner's total compensation and benefits, on the basis that the buyer will step into that role. Adjusted EBITDA leaves a market-rate cost for that role in the numbers, on the basis that the buyer will employ a manager. SDE is therefore the larger figure, and it carries the lower multiple. Comparing an SDE multiple with an EBITDA multiple without converting between them is the most expensive arithmetic error in small company valuation.
Do I include the property in the valuation?
Usually the operating business and the real estate are valued separately. The business is valued on its earnings after a market rent, and the property is valued as property. If the owner has been charging the business below-market rent, the earnings must be restated downward before the multiple is applied, or the business valuation double counts the benefit of owning the building.
How do buyers treat growth?
Buyers pay for demonstrated growth far more readily than for projected growth. Three filed years showing consistent organic growth in the recurring base will move a multiple. A forecast showing a step change next year will not, unless the contracts behind it are already signed, in which case it can be reflected as a run-rate adjustment with the contracts as evidence.
Is a discounted cash flow valuation worth doing?
As a cross-check, yes. As the primary basis for a lower middle market transaction, rarely, because the result moves substantially with small changes to the discount rate and terminal assumptions, and because buyers in this market negotiate on multiples. Its real use is testing whether the growth implied by a proposed multiple is one the business can actually deliver.
Can I value the business myself?
You can get to a defensible range yourself if you rebuild the earnings honestly and resist the temptation to add back items you cannot evidence. The part most owners cannot do alone is the comparable evidence, because credible private transaction data and the current acquisition criteria of active buyers are not public. That is the part worth getting from someone who sees those transactions.
What should I do first?", answer:
Get the earnings rebuilt properly, because every other number on this page depends on it. The free written valuation report performs that rebuild, prices recurring revenue separately, and identifies the specific factors holding the multiple down, with no obligation attached.
Selling a Business in the US
What Is My Business Worth
How private companies are valued in the US lower middle market: normalized earnings, comparable multiples, and the bridge from enterprise value to seller proceeds.
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Questions owners ask before they start
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