How to value a small business

Value is a range, not a single number

A business is worth what an informed buyer will pay, so valuation produces a defensible range backed by clean records.

No formula gives a final price. Methods give you a starting range, then risk, growth, the quality of your records and the market narrow it. A business with steady profits, documented systems and many customers is worth more than an identical one that depends on its owner and two clients.

Start by collecting at least three years of tax returns, profit and loss statements, balance sheets, a customer list by revenue and a list of equipment. If your books are messy, tidy them before anyone else sees them. The business valuation methods article gives a wider overview.

Method one: a multiple of earnings

The most common small-business approach multiplies seller's discretionary earnings or EBITDA by a multiple that reflects industry and risk.

Seller's discretionary earnings, often abbreviated SDE, equal net profit plus owner pay, owner perks, interest, depreciation and one-time expenses. It shows how much the business produces for a single owner-operator. Larger companies are usually valued on EBITDA, which is earnings before interest, taxes, depreciation and amortization.

Illustrative example: net profit is $60,000. Add $70,000 of owner salary, $10,000 of depreciation and $5,000 of a one-time legal expense. SDE is $145,000. If similar businesses in the trade sell at between 2 and 3 times SDE, the range is $290,000 to $435,000. The multiples in your industry vary, so ask a business sales advisor or accountant who knows your sector what current ranges look like instead of relying on a rule of thumb.

Be honest with add-backs. Buyers and their advisers will test each one, and an aggressive list that cannot be documented lowers trust. Keep receipts and records for every item you adjust, and expect to explain why an expense is truly one-time.

Method two: asset-based value

Asset-based valuation adds up what the business owns, subtracts what it owes, and fits companies heavy in equipment, inventory or real estate.

Take the fair market value of equipment, vehicles, inventory and other assets, then subtract liabilities. A trucking or manufacturing business may be worth mainly its equipment, while a consulting firm owns little of value on paper. Be careful to use market value, not book value. An old machine carried at $5,000 on the books may be worth more or less in a sale.

This method often sets a floor. If earnings are weak, the assets may be worth more than the business as a going concern. Read the assets, liabilities and equity guide to check how your balance sheet is built.

Method three: market comparisons

Comparing your business with recently sold, similar businesses shows what buyers actually paid.

Advisors and industry databases track sales by size and type. If three comparable shops in your region sold for between 0.4 and 0.6 times annual revenue, that gives a quick cross-check on the earnings method. Comparable sales are hard to find for very small or unusual businesses, and details differ: lease terms, owner involvement, location, growth.

Use comparisons as a reasonableness test. If your earnings method suggests $400,000 and nearby sales cluster at $250,000, find out why before setting a price.

Revenue multiples are a rough guide only, since two businesses with the same sales can have very different profit. Treat them as a sanity check rather than a price.

What raises or lowers the number

Buyers pay more for steady profit, diverse customers and transferable systems, and less for owner dependence and uncertainty.

Factors that tend to increase value:

• Rising revenue and stable or improving margins.
• Recurring or repeat revenue.
• No customer above a modest share of sales.
• Documented processes, trained staff and a business that runs without the owner every day.
• A lease with years remaining and clean financial records.

Factors that tend to lower it: declining sales, a single large client, unpaid taxes, outdated equipment, pending disputes and sloppy books. Each of these can be improved in the year before a sale. Our guide on selling a small business covers preparation.

Start improving things early. Even six to twelve months of cleaner books, a written operations manual and a plan to reduce reliance on your top customers can change how a buyer sees the risk.

Next steps: get a professional opinion

Use the methods to form a range, then confirm it with an accountant, sales advisor or certified appraiser before you list or buy.

For a sale, an advisor brings buyers and market knowledge. For a bank loan, SBA lending or legal matters such as divorce or partner buyouts, an independent appraisal may be required. Fees vary, so ask for quotes.

If you are the buyer, ROI Funder does not place acquisition loans, and you should check with the SBA for programs relevant to purchasing a business. If the purchased business later needs working capital for payroll or inventory, that is a different need, and ROI Funder can help once the business has 6+ months of operating history under your ownership and meets the revenue and credit guidelines. Read the acquisition guide for the buyer's perspective.