Valuation
How to value a small business
The asking price is a starting point for negotiation, not evidence of value. Value comes from verified earnings and the risk that those earnings continue after you take over.
Where the cash goes
Annual amounts in USD, before income taxes.
- Stated SDE
- $175,000
- Replacement pay
- −$60,000
- Capex reserve
- −$15,000
- Debt service
- −$72,865
- Annual cash flow
- $27,135
Fictional example: $500,000 price, $175,000 SDE, 10% down, 10.5% loan over 10 years. Change the assumptions in the calculator.
Small businesses are usually priced as a multiple of SDE. The temptation is to look up a typical multiple for the industry, multiply, and call it value. That approach skips the only question that matters: how likely is it that these earnings continue once the current owner leaves?
The multiple is a risk score in disguise
A multiple is the inverse of a return. Paying 3× SDE means the business's cash flow repays the price in roughly three years before debt costs, taxes and your own salary. A buyer accepts a lower multiple (a higher return) when the earnings are riskier, and pays a higher multiple when they are safer. So the useful work is not finding the right multiple. It is understanding the risk.
What makes earnings safer
- Recurring or contracted revenue. Maintenance agreements, subscriptions and multi-year contracts carry over to a new owner more reliably than one-off sales.
- A spread-out customer base. No single customer providing more than about 10 to 15% of revenue.
- A team that runs the day-to-day. The less the business depends on the owner's personal relationships and skills, the more transferable it is.
- Documented processes. Pricing, scheduling, quality checks and hiring written down, not held in someone's head.
- Stable or growing trend. Three years of rising revenue and margin.
- Transferable licenses, leases and supplier terms, confirmed in writing.
What makes earnings riskier
- The owner is the main salesperson, technician or relationship holder.
- One customer, one supplier or one platform dominates.
- Revenue is declining, or margins are shrinking while revenue grows.
- Equipment or facilities need major spending soon.
- A lease expires shortly after closing with no assignment or renewal option.
- Records are poor, or income does not reconcile to bank deposits.
From risk to an offer
- Rebuild SDE from tax returns and documents. See What SDE is.
- Subtract what you will have to spend: a fair wage for whoever runs the business and an annual capex reserve.
- Check what the cash flow can support. At a given price and structure, can the business cover its debt with room to spare? Use the valuation calculator and the SBA loan calculator.
- Adjust for the risks you found. Each serious risk either lowers the price, moves risk to the seller (a seller note, an earnout, a longer transition), or ends the deal.
- Write down why. An offer with reasons attached is easier to defend and harder to argue up.
A worked example
A business shows stated SDE of $200,000 and asks $700,000 (3.5×). Your rebuild finds $20,000 of add-backs without support, and the business needs a $15,000-a-year equipment reserve. Verified, reserve-adjusted earnings are $165,000. At the same 3.5×, that supports about $577,500, not $700,000, before you have considered any specific risk. If a third of revenue comes from one customer, you might offer less, ask the seller to carry a note, or tie part of the price to that customer staying.
Market data has a place
Comparable sale data from brokers and industry sources is useful context, especially to understand what sellers expect. Treat it as context. Published averages mix businesses of very different quality, and a number on a page tends to become an anchor.