💰 How to Value a Small Business: 5 Proven Methods

Executive Summary: This comprehensive guide explains five proven methods for valuing small businesses, from simple earnings multiples to complex DCF models. Learn how to calculate SDE vs EBITDA, apply industry-specific valuation multiples, and ensure your valuation meets SBA lending requirements for business acquisition financing.

You've found a business you want to buy. The owner says it's worth $2 million. Is that right?

Some buyers negotiate on gut feel. But you can strengthen your negotiating position by rooting your argument in proven methods and data. Valuing a small business isn't mysterious—it's math, benchmarks, and discipline.

Here's how to determine what a business is actually worth.

Every business valuation starts with one number: how much money the business makes.

For businesses under $2 million in revenue, use Seller's Discretionary Earnings (SDE). This is the business's profit plus the owner's salary and benefits. It shows the total economic benefit to one owner-operator.

For larger businesses, use EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This measures operational performance independent of financing and accounting decisions.

Get the last three years of tax returns and financial statements. Average the SDE or EBITDA, giving more weight to recent years. This becomes your baseline.

One critical note: SBA lenders base their calculations on tax returns, not the adjusted financials sellers present. Live Oak Bank's SBA lending team and other lenders verify addbacks through W-2s and general ledgers. Undocumented "seller discretionary expenses" won't count toward cash flow for loan purposes, even if they're real.

The most common valuation method multiplies SDE or EBITDA by an industry-specific multiple.

Small business multiples typically range from 2x to 4x SDE. According to Live Oak Bank, one of the nation's largest SBA lenders, purchase price multiples generally fall in the 3-4.5x EBITDA range. A landscaping company might sell for 2.5x SDE while a SaaS business might command 4x or higher. The multiple depends on:

A business with $325,000 SDE at a 3x multiple = $975,000 valuation.

Sometimes the parts are worth more than the whole.

Asset-based valuation adds up everything the business owns, then subtracts what it owes. This method works best for:

Don't use book value from the balance sheet. Equipment depreciates for tax purposes faster than its actual useful life. Get appraisals for major assets.

Some industries consistently trade on revenue multiples rather than earnings.

This method makes sense for:

A $1 million revenue accounting firm at 1.2x = $1.2 million valuation.

Revenue multiples assume industry-normal profitability. If margins differ significantly from industry standards, adjust accordingly.

DCF projects future cash flows and discounts them to present value.

This method suits:

While theoretically sound, DCF requires many assumptions. Small changes in growth rate or discount rate dramatically affect valuation. Use it as a cross-check, not your primary method.

What did similar businesses actually sell for?

This market approach grounds your valuation in reality. Find 3-5 recent sales of comparable businesses:

If three similar businesses sold for 2.8x, 3.1x, and 3.3x SDE, expect yours to fall in that range.

Smart buyers don't rely on one method. They triangulate.

Run three valuation methods, then weight them based on reliability:

Weighted average = $925,000

This balanced approach prevents any single method's weakness from distorting your valuation. For instance, a plumbing company with $380,000 SDE might seem worth $1.2M at 3.2x multiples, but if comparable sales show a $1.15M-$1.35M range and the asset value is only $300,000, you know to target the lower end of that range.

Every business has unique factors that increase or decrease value.

Adjust your base valuation by 5-20% for each major factor.

Before finalizing your valuation, ask yourself:

Can this business service acquisition debt at this price? Here's the critical disconnect: sellers value businesses on future projections, but lenders use historical tax returns. Most SBA lenders require 1.25-1.5x debt service coverage based on the last full year's tax return—not your optimistic projections. If historical cash flow doesn't support the debt at 1.5x coverage, your valuation is too high regardless of future potential.

Would you rather buy this business or start your own? If starting fresh seems easier, the premium for buying isn't justified.

What's your return on investment? Target at least 20-30% annual ROI for the risk you're taking. A $900,000 business generating $300,000 annually delivers 33% ROI—reasonable for the work and risk involved.

Your valuation isn't the price you'll pay—it's your negotiation anchor.

Sellers typically list 10-20% above fair value. Your valuation tells you where to start negotiations and when to walk away. If a business valued at $900,000 lists for $1.3 million, you know there's room to negotiate. If it lists for $950,000, it might be priced fairly.

Remember: terms can be worth more than price. Seller financing at 10-15% of purchase price for 5-10 years is standard per SBA lending guidelines. Earnouts and rollover equity are prohibited under SBA rules, but forgivable seller notes tied to historical metrics are allowed. Working capital adjustments can significantly affect the real cost—budget 30-60 days of working capital on top of the purchase price.

Before making an offer, ensure you've completed:

□ Obtained 3 years of tax returns and financial statements
□ Calculated SDE or EBITDA for each year
□ Researched industry-specific valuation multiples from multiple sources
□ Run at least 3 different valuation methods
□ Found 3-5 comparable sales in your market
□ Adjusted for business-specific risk factors
□ Verified the business can support 1.25x+ DSCR at your price
□ Confirmed working capital needs with monthly P&Ls
□ Had preliminary discussion with SBA lender about loan terms
□ Factored in all acquisition costs (legal, valuation, due diligence)
□ Created sensitivity analysis for different scenarios
□ Reviewed customer concentration and revenue quality

The multiple of earnings method is most reliable for established businesses with consistent cash flow. Industry-standard multiples typically range from 2-4.5x SDE. However, smart buyers use at least three methods and weight them appropriately. For businesses under $2M in revenue, focus on SDE multiples verified through tax returns.

Revenue multiples work best for high-growth businesses, recurring revenue models, or industries with standardized margins like accounting practices or insurance agencies. However, earnings-based valuations are more accurate for most small businesses since they reflect actual profitability. Only use revenue multiples when earnings are temporarily depressed or in specific industries where it's standard practice.

Most SBA lenders require 1.25x DSCR (or higher) based on historical tax returns, not projections. Live Oak Bank and other major lenders require 1.5x and calculate this using the last full fiscal year's verified cash flow. The business must generate $1.50 in cash flow for every $1.00 in debt service. This requirement often limits what buyers can actually pay, regardless of the seller's asking price.

An accurate valuation passes three tests: it's supported by multiple calculation methods, comparable sales validate the price range, and the business can service acquisition debt at that price. Get a third-party valuation for deals over $350K—it's required for SBA loans anyway. If your valuation differs by more than 20% from professional estimates, revisit your assumptions.

Inventory at cost is typically included in asset purchases, while working capital is negotiated separately. Budget 30-60 days of working capital needs on top of the purchase price. Many deals include a working capital adjustment mechanism—if working capital at closing differs from a target amount, the price adjusts accordingly. This prevents sellers from draining cash before closing.

Valuing a business properly takes time and data. Start here:

Here's what the textbooks don't tell you: valuation is your starting point, not your ending point.

In a competitive market with multiple bidders, businesses often sell above "fair" value. That premium isn't necessarily irrational. The winning buyer might see operational improvements others miss—cutting costs by 10%, adding a complementary service line, or leveraging existing customer relationships to drive growth.

The key is knowing your unique advantage. Can you:

If you can increase cash flow by 20% in year one, paying 3.5x instead of 3x might make perfect sense. Your operational improvements become your competitive edge in bidding.

But don't confuse optimism with strategy. Document exactly how you'll improve the business, with specific numbers and timelines. If you're betting on "working harder" or "being smarter," you're probably overpaying.

The best acquisitions happen when analytical rigor meets entrepreneurial vision. Know what the business is worth today, understand what it could be worth under your ownership, and let that gap guide your offer. In the end, the "right" price is the one where the business thrives under your leadership while delivering your target returns.

Disclaimer: This guide is for educational purposes only and does not constitute legal, financial, tax, or investment advice. Business acquisitions involve significant risks, and outcomes can vary widely based on individual circumstances. Always consult with qualified professionals including attorneys, CPAs, and financial advisors before making acquisition decisions. The EBIT Community does not guarantee the accuracy of information provided or the success of any acquisition strategy. Past performance and examples do not guarantee future results.