How to Value a Small Business: 5 Methods

Introduction

Business valuation is both an art and a science. There's no single formula that works for every business, which is why professional appraisers and experienced brokers use multiple methods and triangulate to arrive at a fair value. Here are the 5 most commonly used valuation methods for small businesses.

Method 1: SDE Multiple (Most Common)

The Seller's Discretionary Earnings (SDE) multiple method is the most widely used for small businesses (under $5M in value).

How it works:

1. Calculate SDE: Net profit + owner salary + owner benefits + one-time expenses + depreciation + interest
2. Apply an industry-appropriate multiple (typically 1.5x to 4x)
3. Business value = SDE × Multiple

Example: A business with $150,000 SDE at a 3x multiple = $450,000 value

Multiples vary by industry, growth rate, risk level, and market conditions. Service businesses typically sell for 1.5-2.5x SDE, while businesses with recurring revenue (like SaaS or maintenance contracts) can command 3-5x.

Method 2: EBITDA Multiple

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the preferred metric for larger businesses (above $5M in value) or businesses with professional management.

EBITDA differs from SDE in that it does NOT add back the owner's salary — it assumes the business pays a market-rate manager. EBITDA multiples typically range from 3x to 7x for small-to-mid-size businesses.

When to use EBITDA: When the business has (or needs) a paid manager, when the buyer is an investor rather than an operator, or when comparing to public company valuations.

Method 3: Revenue Multiple

Some businesses (especially fast-growing or unprofitable ones) are valued based on a multiple of annual revenue.

Revenue multiples typically range from 0.25x to 2x annual revenue for small businesses. SaaS companies and tech businesses can command higher multiples (3-10x revenue).

When to use revenue multiples: When the business is early-stage or unprofitable but has strong revenue growth, when SDE/EBITDA are not meaningful metrics, or as a sanity check against other methods.

Limitation: Revenue multiples ignore profitability. A $1M revenue business with 5% margins is worth far less than a $1M revenue business with 25% margins.

Method 4: Asset-Based Valuation

This method values the business based on the fair market value of its assets minus liabilities.

When to use it: For asset-heavy businesses (manufacturing, equipment rental, real estate), for businesses being liquidated, or as a floor value (the business should be worth at least the value of its assets).

How it works: Add up the fair market value of all tangible assets (equipment, inventory, vehicles, real estate) and intangible assets (brand, customer lists, intellectual property). Subtract all liabilities. The remainder is the business value.

This method often undervalues profitable businesses because it doesn't fully capture the earning power of the business as a going concern.

Method 5: Discounted Cash Flow (DCF)

DCF values a business based on the present value of future cash flows. It's the most theoretically sound method but requires the most assumptions.

How it works:

1. Project future cash flows for 5-10 years
2. Determine a discount rate (typically 15-30% for small businesses, reflecting risk)
3. Calculate the present value of each year's cash flow
4. Add a terminal value for cash flows beyond the projection period
5. Sum all present values to arrive at the business value

When to use DCF: For businesses with predictable, growing cash flows. DCF is most useful when combined with other methods.

Limitation: Small changes in assumptions (growth rate, discount rate) dramatically change the result. As the saying goes: 'A DCF will tell you whatever you want to hear.'

Choosing the Right Method

In practice, experienced valuators use multiple methods and compare the results:

• Primary method: SDE multiple for owner-operated businesses, EBITDA multiple for professionally managed businesses
• Reality check: Compare the result to recent comparable sales (if available)
• Floor value: Asset-based valuation sets the minimum
• Growth story: DCF or revenue multiples for businesses with strong growth trajectories

The final value is typically a weighted average of the results from multiple methods, adjusted for business-specific factors like customer concentration, owner dependence, lease terms, and growth potential.

Key Takeaways

Business valuation is both an art and a science. While formulas and multiples provide a starting framework, the actual value of a business depends on market conditions, buyer motivation, and negotiation. Work with a qualified business appraiser or experienced broker to get an accurate valuation before buying or selling.

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