finance
Business Valuation
Estimating what the business is worth - typically as a multiple of EBITDA or revenue.
Definition
Business valuation estimates the market value of the business, usually for sale, investment, or partnership purposes. Common methods: EBITDA multiple (most common for established service businesses - typically 3-7x adjusted EBITDA), revenue multiple (for high-growth SaaS - 3-10x ARR), discounted cash flow (sophisticated buyers), and asset-based (for asset-heavy businesses). Adjusted EBITDA strips out owner-specific items (above-market owner salary, personal expenses) to show what the business would generate under new ownership. Valuation is part math, part market - buyers ultimately set the price.
US small business valuation methods
Three primary methods. EBITDA multiple: most common for established service businesses, applied to adjusted EBITDA at multiples of 2 to 7x depending on size, growth, and recurring revenue mix. SDE (Seller's Discretionary Earnings) multiple: variant used for small businesses under 1M EBITDA; SDE equals EBITDA plus owner add-backs (excess owner salary, personal expenses run through the business, one-time costs). Multiples 1.5 to 4x. Revenue multiple: dominant for high-growth SaaS and recurring revenue businesses; multiples 1x to 10x ARR depending on growth rate and retention. DCF (Discounted Cash Flow): sophisticated method using projected cash flows discounted to present value at a risk-adjusted rate (typically 12 to 20 percent for US small business). Used by PE firms and strategic buyers, rarely by main-street acquirers. Asset-based: only relevant for asset-heavy businesses (manufacturing, real estate); rarely used for service businesses.
What drives the multiple within a range
Two service businesses with identical EBITDA can sell at very different multiples. Factors that raise the multiple. Recurring revenue mix: 80 percent recurring beats 20 percent project. Customer concentration: no single customer over 10 percent beats top customer at 30 percent. Growth rate: 30 percent year over year beats flat. Owner dependency: business runs without founder beats founder runs everything. Documented systems: SOPs and playbooks exist beats tribal knowledge. Strong team: key people will stay post-sale beats founder is the only expert. Clean books: GAAP-compliant accounting beats messy cash books. Each factor adjusts the multiple within the range; the combined effect can be 2x to 3x between a poorly-prepared business and a well-prepared one with identical EBITDA.
Preparing for a sale 2 to 3 years out
The highest-leverage time horizon for US small business sale preparation is 24 to 36 months. Key moves. Clean up the books: separate personal and business expenses, GAAP-compliant accrual accounting, monthly close discipline. Reduce owner dependency: document SOPs, hire managers, build a non-founder leadership team. Diversify customer base: reduce top customer concentration, build pipeline diversity. Build recurring revenue mix: convert project work to retainers, add subscriptions. Document systems: every recurring process should have a written playbook. Reduce founder add-backs: while add-backs are legitimate, fewer add-backs means cleaner financials and higher buyer confidence. Two to three years of disciplined preparation typically lifts sale multiple by 1 to 2x and reduces deal failure risk by half.
Buyer types and what each pays
Four main US buyer types. Strategic acquirer: another business in your industry buying for synergies. Pays highest multiples (often 6 to 12x EBITDA) when synergy is real. PE firm: financial buyer building a portfolio. Pays middle multiples (4 to 7x EBITDA) and brings operational discipline. Search fund or independent sponsor: individual or small team raising capital to buy one business. Pays middle multiples (3 to 6x EBITDA). Main-street buyer: individual buying for owner-operator role. Pays lowest multiples (1.5 to 4x SDE). Each buyer type has different criteria; preparing for the highest-multiple buyer type is the most leveraged sale preparation. Strategic buyers want clean financials, scalable systems, and clear synergies; PE wants growth and recurring revenue; main-street buyers want manageable operations and SBA-financeable structure.
FAQ
When should I get a business valuation?
Three trigger events. One, when planning to sell within 2 to 3 years; baseline valuation reveals gaps to address. Two, when partner buy-ins, buyouts, or estate planning create need. Three, when bringing in outside investment or partner. Annual informal valuation tracking is good discipline for any growing US small business; the discipline reveals which initiatives create or destroy value. Formal valuations from a CPA or business broker cost 2K to 15K and require 30 to 60 days. Do not skip valuation before any material transaction; pricing your business wrong has 6-figure to 7-figure consequences.
What is the difference between SDE and EBITDA?
SDE (Seller's Discretionary Earnings) equals EBITDA plus owner compensation (full salary plus benefits) plus owner-specific add-backs (personal expenses, one-time costs). Used for owner-operated businesses where the new owner will replace the founder. EBITDA is used when the buyer will not replace the founder (a strategic acquirer keeping the management team or PE firm bringing professional management). SDE multiples are lower than EBITDA multiples (1.5 to 4x vs 3 to 7x) because SDE is a larger number reflecting the work the owner currently does. The right metric depends on the buyer type and how they will operate the business post-sale.
Why does owner dependency reduce valuation?
Owner-dependent businesses carry transition risk that buyers price into the multiple. Specific concerns. Will customers leave when founder leaves? (relationship dependency). Can the team operate without founder? (capability dependency). Are systems documented and transferable? (knowledge dependency). Will key suppliers continue terms with new ownership? (supplier dependency). Buyers respond with lower multiples, larger earn-outs (10 to 40 percent of price contingent on post-sale performance), and seller-financing requirements (seller carries portion of purchase price as proof of business durability). Reducing dependency 2 to 3 years before sale directly raises sale price; a 50 percent reduction in owner dependency typically lifts multiple by 0.5 to 1.5x.
Should I use a business broker or sell directly?
For US small businesses under 5M revenue, business broker typically pays for itself. Broker fees: 8 to 12 percent of sale price. Broker value: deal flow (multiple buyers), valuation expertise, deal structuring, confidentiality management, transaction management. Going direct works when: you already have a specific buyer (competitor, employee, family member), the deal structure is simple, and you have transaction expertise. M&A advisors and investment banks fit businesses above 5M revenue, charging 1 to 3 percent of larger deal values. Match advisor cost to deal complexity; under-spending on advisory commonly produces worse net outcomes than the savings.
What multiple should I expect for my US service business?
Depends on size, growth, and recurring revenue mix. Under 250K SDE: 1.5 to 3x SDE. 250K to 1M SDE: 2.5 to 4.5x SDE. 1M to 3M EBITDA: 3 to 6x EBITDA. 3M to 10M EBITDA: 4 to 8x EBITDA. Above 10M EBITDA: 5 to 10x EBITDA. Within each range: higher multiples for recurring revenue businesses, scalable systems, diversified customer base, and growth. Lower multiples for project businesses, owner-dependent operations, customer concentration, and flat growth. SaaS multiples typically 1.5 to 2x higher than services at the same EBITDA. Industry benchmarks from BVR (Business Valuation Resources), Pratt's Stats, and DealStats provide segment-specific guidance.
In your business
- →Track adjusted EBITDA, not just reported EBITDA - it's what buyers will value
- →Reduce owner dependency before selling - dependent businesses sell for 2-3x lower multiples
- →Get a baseline valuation 2-3 years before any sale - gives time to fix what reduces value