How to Value a Small Business: 5 Methods Explained (With an Example)

Most small businesses are valued by taking a reliable profit figure, such as SDE or EBITDA, and multiplying it by a multiple that reflects risk. Asset-based and discounted cash flow methods are used alongside it, depending on the business.

Save this one-page cheat sheet covering add-backs, valuation methods, value drivers and what you actually net at closing.

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"So what's it worth?" It's the question almost every owner asks eventually, and most only ask it once, usually when someone else is already at the table.

The good news is that small business valuation isn't a mystery. Professionals use a handful of standard methods, and once you understand them you can estimate your own value, see what's dragging it down, and work on the things that raise it. This guide explains each method in plain English, walks through a worked example, and shows you what actually moves the number.

Why owners should know their value (even if they're not selling)

Your valuation is the scoreboard for everything you do in the business. More revenue, more profit and more time back all add up to a higher number. Knowing it helps you:

• Decide which improvements are worth your time and money
• Plan for retirement, succession or bringing in a partner
• Set up a buy-sell agreement or estate plan
• Talk to lenders and investors with confidence
• Know where you stand if an unexpected offer shows up

Start with the right profit number

Most small business valuations are built on a measure of profit, so the first job is getting that number right. Two measures matter most.

Seller's discretionary earnings (SDE)

SDE is the total financial benefit one full-time owner gets from the business. It's typically used for smaller, owner-operated businesses.

SDE = pre-tax net profit + one owner's total compensation + interest + depreciation and amortization + documented add-backs

EBITDA (earnings before interest, taxes, depreciation and amortization)

EBITDA is used more often for larger businesses with a management team in place. The key difference from SDE: EBITDA assumes the owner's role is filled by someone paid a market salary, so that salary stays in as an expense.

Adjusted EBITDA = pre-tax net profit + interest + depreciation and amortization + documented add-backs + (owner pay above market rate)

Add-backs: the profit hiding in your books

Add-backs are expenses that a new owner wouldn't have: personal vehicle costs, family members on payroll who don't work in the business, one-time legal fees, personal travel and so on. Documented add-backs raise your SDE or EBITDA, and undocumented ones usually get thrown out. See our list of 40 common add-backs for a full rundown.

The 5 ways small businesses are valued

1. The earnings multiple method (market approach)

This is the method used most often for small businesses. You take a profit figure (SDE or EBITDA) and multiply it by a multiple based on what similar businesses have actually sold for.

Value = SDE (or EBITDA) × multiple

Multiples come from databases of completed transactions such as DealStats, BIZCOMPS and BizBuySell's market reports, which brokers, appraisers and SBA lenders use. Multiples for small, owner-operated businesses are commonly in the low single digits of SDE, while larger businesses with management teams often trade at higher EBITDA multiples. The exact multiple depends on industry, size, growth and risk, which is why two businesses with the same profit can be worth very different amounts.

Best for: profitable businesses in industries with plenty of comparable sales.

2. Comparable sales (market approach)

Closely related to the multiple method, this looks directly at the sale prices of similar businesses, often as a multiple of revenue, SDE or EBITDA, and adjusts for differences in size, location, growth and condition. It's how most people think about home prices: what did the similar house down the street sell for?

Best for: a reality check on any other method.

3. Capitalization of earnings (income approach)

This method divides a single year of expected, normalized earnings by a capitalization rate that reflects the risk of the business and its expected long-term growth.

Value = expected annual earnings ÷ capitalization rate

The capitalization rate is the required rate of return minus the long-term growth rate. A riskier business has a higher required return, a higher cap rate and a lower value. It's simple, but it assumes earnings are stable and growing at a steady rate.

Best for: mature, steady businesses with predictable earnings.

4. Discounted cash flow (income approach)

A discounted cash flow (DCF) analysis projects the business's cash flows for several years, estimates a value at the end of that period, and discounts it all back to today using a rate that reflects risk.

Value = present value of projected cash flows + present value of terminal value

DCF is powerful but sensitive: small changes to growth or discount rate assumptions can swing the result a lot. It's used more for larger or fast-growing companies than for Main Street businesses.

Best for: businesses whose future will look very different from their past.

5. Asset-based valuation (asset approach)

This method adds up the fair market value of everything the business owns and subtracts what it owes. Adjusted net asset value uses current market values rather than book values. Liquidation value estimates what the assets would bring if sold off.

Value = fair market value of assets − liabilities

For most profitable service businesses, the asset approach gives a lower valuation than the earnings-based methods, because it ignores the value of the customers, team and systems. For asset-heavy businesses, or ones that aren't making money, it can be the most relevant method and often sets a floor.

Best for: asset-heavy businesses, holding companies, or businesses with little or no profit.

A note on rules of thumb

Some industries have shortcuts, such as a multiple of annual revenue. They're fine for a rough first look, but they ignore profitability, so two businesses with the same revenue and very different margins get the same answer. Use them as a sanity check, not a valuation.

A worked example

Here's a simplified example for an imaginary HVAC company. The numbers are illustrative, not a benchmark.

If comparable HVAC businesses of this size have sold at around 2.5 to 3.0 times SDE, the estimated range is $950,000 to $1,140,000.

Now say the owner does three things over two years: moves half of residential customers onto maintenance agreements, promotes a field manager who runs jobs without him, and documents the add-backs he'd been ignoring. SDE rises, the risk falls, and the multiple a buyer, lender or successor would apply rises with it. The same business could be worth meaningfully more without adding a single truck.

The methods at a glance

Professionals often use more than one method and weigh the results, which is why a valuation usually comes back as a range rather than one number.

How to estimate your own value in 5 steps

Step 1: Gather three years of financials

Profit and loss statements, balance sheets and tax returns for the last three years, plus year-to-date numbers.

Step 2: Recast your profit

Start with pre-tax profit, then add back owner compensation (for SDE), interest, depreciation, amortization and documented add-backs. Do it for each year to see the trend.

Step 3: Pick a realistic multiple range

Look for transaction data for your industry and size. Your accountant, an SBA lender or a valuation professional can point you to sources. Be honest about where your business sits in the range.

Step 4: Adjust for what's included

Decide how you'll treat cash, debt, working capital, inventory and real estate, so you're comparing like with like.

Step 5: Cross-check with a second method

Compare your result to the asset value as a floor, and to any rules of thumb for your industry. If the numbers are far apart, find out why.

What moves your multiple up or down

Two businesses with the same profit can carry very different multiples. These are the factors that matter most:

• Owner dependence. If the business can't run without you, it's riskier and worth less.
• Customer concentration. Heavy reliance on one or a few customers lowers value.
• Recurring revenue. Contracts, memberships and maintenance agreements raise it.
• Financial quality. Clean, monthly, reconciled books that match tax returns raise confidence.
• Growth. Steady, provable growth beats flat or lumpy results.
• Margins. Higher margins than peers suggest pricing power and good management.
• Team. A second layer of leadership and low turnover reduce risk.
• Size. Larger businesses generally command higher multiples.
• Transferability. Assignable contracts, a secure lease and current licenses make the business easier to take over.

Every one of these is something you can work on. For 37 specific moves, see our guide on how to increase the value of your business.

What's usually included, and what isn't

When people quote a value for a small business, it often assumes a few things that are worth knowing:

• Cash and debt. Many small business values assume the business is delivered cash-free and debt-free: the owner keeps the cash and pays off the debt.
• Working capital. A normal level of receivables, inventory and payables is often expected to stay with the business.
• Real estate. If the owner owns the building, it's usually valued separately and leased to the business.
• Asset sale vs. stock sale. Most small business transfers are structured as asset sales, which has tax consequences for both sides. Talk to your accountant.

When to get a professional valuation

An estimate is enough to plan and to track progress. A formal valuation from a credentialed appraiser (for example, someone holding the ASA, ABV, CVA or CBA designation) is the right call for estate and gift tax filings, buy-sell agreement triggers, divorce, disputes, ESOPs, and any situation where the number has to stand up to scrutiny.

Common mistakes owners make

• Using revenue instead of profit
• Applying a multiple from a much larger company or a different industry
• Counting add-backs that aren't documented
• Ignoring owner dependence and customer concentration
• Getting a valuation once and never checking it again

Related Valuexus guides

• Read our guide on valuation multiples by industry.
• Read our guide on how much your small business is worth.

Frequently asked questions

How much is a business worth with $1 million in revenue?

It depends almost entirely on profit, not revenue. A $1 million business earning $250,000 in SDE and one earning $50,000 are worth very different amounts. Start with SDE, then apply a multiple for your industry and size.

Is a business worth 3 times profit?

Sometimes. Many small owner-operated businesses do trade in the low single digits of SDE, but the right multiple depends on industry, size, growth, owner dependence and risk. Treat any single number as a starting point.

Does the value include inventory?

It varies. Some valuations include a normal level of inventory and others add inventory on top at cost. Make sure you know which assumption is being used.

How often should I value my business?

At least once a year, and any time you're making a big decision. Owners who track it monthly can see which changes actually raise it.

Know your valuation, then grow it

A valuation is most useful when it's tracked, not taken once. When you can see what your business is worth every month, you can see which changes actually raise it. We call it Live Value: your valuation in minutes, the moves that raise it most, and your valuation tracked as you grow.

More revenue. More profit.

More time back. A higher valuation is what all three add up to.

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