How to Value a Small Business

Start with seller's discretionary earnings (SDE)

SDE is the total financial benefit the business gives its owner in a year. Start with pre-tax profit, then add back the owner's salary, personal expenses run through the business, one-time costs, interest, and depreciation. A business showing a small profit on its tax return often generates far more for its owner than it appears to.

Example: a landscaping company shows $60,000 of net profit. The owner pays himself $80,000, runs a $12,000 vehicle through the books, and had a one-time $15,000 legal bill. SDE is roughly $167,000. That is the number you are actually buying.

Apply a multiple

Small businesses typically sell for a multiple of SDE, and for most Main Street deals that multiple lands somewhere between 2x and 4x. Where a specific business falls in that range depends on a handful of factors:

• Owner dependence. A business that collapses without the owner is worth less than one with a manager and systems in place.
• Revenue quality. Recurring contracts and repeat customers push the multiple up. One-off project work pushes it down.
• Customer concentration. If one customer is 40% of revenue, buyers discount heavily for the risk of losing them.
• Trend. Three years of growth earns a better multiple than three years of decline, even at the same SDE.
• Industry. Some industries trade richer than others. See the industry breakdowns for what to expect in each category.

A worked example

An HVAC company has SDE of $300,000, three years of steady growth, service contracts covering half its revenue, and a general manager who runs day-to-day operations. That profile might support a 3.5x multiple, or about $1,050,000. The same SDE in a business where the owner is the only licensed technician and two customers make up half the revenue might only justify 2x, or $600,000. Same earnings, very different price.

What buyers get wrong about valuation

• Trusting the broker's number. The asking price is a starting point for negotiation, not an appraisal. Rebuild SDE from the tax returns yourself.
• Paying for potential. Growth you have to create is your upside, not the seller's. Pay for what the business earns today.
• Ignoring what the price must support. The price has to leave enough cash flow to cover loan payments and pay you. Run the numbers in the deal analyzer before falling in love with a multiple.

Next step: how buyers finance a purchase, or the full cost of buying a business.

Michael Freedman

Florida licensed business broker. 14+ years buying and selling businesses, 1,000+ evaluated, $100M+ in deals closed and advised on.

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