Practical Valuation Guide For Small Businesses

For most small business owners, their company represents their single largest asset—often accounting for 80-90% of their net worth. Yet unlike a home value (which they can check on Zillow) or a stock portfolio (which they can monitor daily), most business owners don’t have a clear picture of their business worth or market value.

Regardless of where you are in your entrepreneurial journey, not knowing the value of your business can have costly consequences:

1. If you plan on selling your business in the future: If your market value

   falls short of your financial or retirement planning goals, you’ll have time to make operational improvements to bridge that gap.

2. If you are looking to sell your business today: It prevents costly mistakes during negotiations. Without a solid understanding of your business’s worth, you risk either accepting a lowball offer that leaves money on the table, or rejecting a fair offer because it didn’t match your expectations.

Many owners find the valuation process daunting, but it doesn’t have to be. In this article, we will teach you everything you need to know about valuation methods for your small business and provide actionable advice on what you can do today to increase its value.

What You'll Learn

In this comprehensive guide, you'll discover:

• Valuation Fundamentals: How prospective buyers think about business value and the basic formula they use (Profitability × Multiple)

• Understanding Business Profitability: How to calculate your true profitability using EBITDA or SDE, including common adjustments and real examples

• Valuation Multiples: What drives your multiple higher or lower, from both market conditions and company-specific factors

• Alternative Valuation Methods: When and why asset-based or revenue-based approaches might be more appropriate

• Practical Steps: How to value your own business and what to watch out for in the process

By investing just a few minutes, you'll learn everything you need to know about how businesses are valued and what you can do to maximize your business’s worth.

Valuation Fundamentals: Understanding the Framework

No matter how much blood, sweat, and tears you’ve put into building your company, its value ultimately comes down to what prospective buyers are willing to pay. To maximize your business worth, you need to understand how people on the other side of the deal think about valuation.

Buyers typically determine a business’s value using a straightforward formula:

Business Value = Current Profitability x Valuation Multiple

Let's break this down:

• Current profitability measures how much money your business makes today (often expressed as EBITDA or SDE, which we’ll explain below).

• Valuation multiple reflects how risky buyers perceive your business to be – the lower the risk, the higher the multiple.

Understanding these components is crucial because it shows you exactly where to focus your efforts to increase the value of your business.

Let’s dive into each element to see how this works in practice.

Business Profitability: What It Is and How to Measure It

Not sure what your business’s true profitability is? You’re not alone. Most business owners know their top-line revenue numbers but have little understanding of their true bottom line. While sales are important, buyers focus primarily on how much money the business generates after all expenses are paid—i.e., cash flow and other profitability metrics.

To standardize this analysis, the industry uses two key profitability metrics, depending on the size of your business:

• For businesses with over $5 million in sales: EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization)

• For businesses with under $5 million in sales: SDE (Seller’s Discretionary Earnings)

Let’s examine each metric to understand which applies to your business and how to calculate it.

Understanding EBITDA

EBITDA is the most common metric that buyers will use to assess your company’s profitability. By excluding interest, taxes, depreciation, and amortization from your net income, EBITDA shows your true operational performance:

EBITDA Example Calculation

Starting with $450,000 of net income:

💡 Key insight: Your business is generating $800,000 in true operational profit—almost double the $450,000 shown on your tax return. Using net income alone would severely undervalue your business.

Understanding SDE

For smaller businesses, EBITDA alone doesn’t usually tell the full story because owners often:

• Pay themselves below-market salaries to minimize payroll taxes.

• Run personal expenses through the business (vehicles, health insurance, travel).

• Employ family members at varying compensation levels.

These practices can significantly understate the true profitability of your business to a buyer. SDE solves this by starting with EBITDA and adding back owner-related expenses to show the full earning potential for a new owner.

SDE Calculation Example

Starting with EBITDA of $300,000, we add back:

As you can see, the business’s true profitability is more than 30% higher than EBITDA suggests. This directly translates into a higher asking price because buyers typically pay a multiple of these adjusted earnings.

One-Time Adjustments: Don’t Forget Non-Recurring Expenses

Regardless of whether you use EBITDA or SDE, you should also identify any one-time or non-recurring expenses that affected your profit. These expenses don’t reflect your ongoing business operations and should be added back:

• Office relocation costs

• Legal fees from a one-time lawsuit

• Costs for a new software system

• Discontinued product lines

• COVID-related expenses (PPE, workplace modifications)

For example, if your business spent $50,000 moving to a new location last year, it should be added back to your EBITDA or SDE since it doesn’t reflect normal operations.

Understanding Valuation Multipliers

Key Valuation Drivers

Think of a valuation multiple like a risk score—it reflects how risky buyers perceive your business to be. The safer the business, the higher the multiple. For example, a business generating $1M in SDE might be worth $3M (3x multiple) or $6M (6x multiple), depending on its risk profile.

Key factors that influence your multiple include:

1. Market conditions: External factors that affect all businesses in your industry.

2. Company-specific characteristics: Factors unique to your business, such as how well you maintain

   financial records, how diversified your customer base is, and whether you rely on physical assets or intangible assets like intellectual property.

Market Factors

Company Specific Factors

Valuing Your Business: A Real-World Example

Let’s say that you own a plumbing company, which typically attracts valuation multiples of 3–6×. Where you land depends heavily on both external market conditions and your specific business model.

Consider these two plumbing companies generating the same profit but having very different valuations:

Why the gap? Company A’s revenue is more predictable, diversified, and resilient to economic swings, which leads to a higher multiple.

Other Valuation Approaches

While earnings-based multiples are the most common valuation methods, there are situations where alternative approaches might be more appropriate.

Asset-Based Valuation

This approach is often used when:

• The business is unprofitable or only marginally profitable.

• Most of the business assets are physical assets (equipment, real estate, inventory).

• The owner needs a liquidation value for a distressed scenario.

In these cases, the business sale price might be based on:

1. The fair market value of all physical assets.

2. Minus any debts or liabilities.

Revenue-Based Valuation

Common in software or high-growth tech firms, a discounted cash flow or a multiple of Annual Recurring Revenue (ARR) can be used—though typically for larger ventures ($10M+ in annual revenue). Smaller software businesses often still rely on EBITDA or SDE because buyers want proven profitability.

Taking Action: Steps to Value Your Business

After understanding how buyers think about market value, here are the key steps to figure out what your company might be worth:

1. Calculate Your True Profitability

• Decide whether EBITDA or SDE fits your size.

• Identify all necessary adjustments

• Ensure your financial statements reflect the final numbers accurately over the last 3 years.

2. Research Industry Valuation Multiples

• Study small businesses that have recently sold if data available

• Gather market data on your industry's typical ranges

• Evaluate current market conditions that could affect your multiple

3. Make Company-Specific Adjustments

• Assess how your company compares to other on size, stability, and reliance on a few customers

• Adjust the multiple up or down based on these specifics

• Factor in how easy it would be to transfer ownership and operate the business

4. Calculate a Valuation Range

• Multiply your adjusted EBITDA or SDE by the chosen multiple.

• Present a range rather than one number.

• Document your assumptions and any valuation methods used.

Important Valuation Considerations

Though these steps seem straightforward, arriving at a precise figure can be tricky:

• Financial Complexity: Numerous add-backs or unclear financial records can obscure your true profitability.

• Limited Market Data: Private transactions make it tough to find exact multiples for similar businesses.

• Subjective Adjustments: Without experience, it’s hard to know how each factor should impact your final price.

Best Practices for Getting It Right

1. Engage Your CPA

   • Have them review and validate your financial statements.

   • Get a professional calculation of adjusted EBITDA or SDE for the last 3 years.

   • Document every adjustment thoroughly.

2. Seek Professional Guidance

• A trusted M&A advisor or business broker can leverage proprietary databases on comparable companies.

• They understand your industry’s price to earnings ratios, typical profit margins, and other critical benchmarks.

• They can also advise on the right market approach, from an asset-based calculation to a present value

  of future cash flow.

⚠️ Warning: Be wary of any free business valuation calculator. While these tools can be a helpful starting point, they often use oversimplified formulas and don’t account for the unique strengths or weaknesses of your business.

Remember: Understanding your business worth is crucial whether you’re planning to sell your business soon or simply want to make informed decisions about growth.

Conclusion: Maximizing Your Business’s Potential

Knowing how to value your company is about more than preparing for a successful sale—it’s about operating from a place of knowledge and strength in the here and now.

Summary

• Understanding Profitability: Helps you identify cost centers, focus on the strongest revenue drivers, and allocate resources more effectively.

• Understanding Value Drivers: Highlights which operational improvements will most increase your

  business worth, making it business attractive to outside buyers and ensuring a smoother sales process down the road.

Next Steps

Whether you’re just starting to think about selling a business or actively meeting with potential buyers, we’re here to help guide your path forward.Schedule a free, confidential consultation with an OffDeal M&A advisor to:

• Understand your business’s current true market value.

• Learn actionable steps to raise the monetary value of your company today.

• Explore the current pool of interested buyers and see how you compare with similar businesses.

OffDeal leverages advanced technology and expertise to help small business owners achieve the same quality of M&A service previously reserved for large corporations. Our mission is to ensure every business owner has the opportunity to maximize their value when they're ready to sell.