If you're thinking about selling your business—or just curious what it might be worth—you've probably realized that figuring out its value isn't as straightforward as you'd hoped. Unlike a house, there's no Zillow estimate. Unlike stocks, there's no ticker price.
The good news: there's a proven methodology that professional business brokers use every day to value small businesses. It combines multiple financial metrics—with SDE (Seller's Discretionary Earnings) being the most important—to arrive at an accurate estimate.
This guide will walk you through exactly how it works.
The Core Formula Behind Business Valuation
At its core, valuing a small business comes down to one formula:
Business Value = Value Metric × Industry Multiple
Simple enough. But here's what most online calculators get wrong: they use just one metric from one year. Professional valuations are more nuanced.
The Three Common Value Metrics
Different metrics tell different stories about a business:
- Revenue: Total sales before any expenses. Useful for businesses with predictable margins or when profitability is temporarily depressed.
- EBIT (Earnings Before Interest and Taxes): Operating profit. Common for larger businesses with professional management in place.
- SDE (Seller's Discretionary Earnings): The true cash benefit to an owner-operator. This is the gold standard for small business valuation.
For most small businesses under $5M in revenue, SDE is the primary metric buyers and brokers focus on.
What is SDE and Why Does It Matter?
SDE represents the total financial benefit available to a single full-time owner-operator. It includes not just net profit, but also:
- Owner's salary and benefits
- Personal expenses run through the business
- One-time or non-recurring expenses
- Interest and depreciation
Think of it this way: if you bought this business tomorrow and ran it yourself, how much money would you actually take home? That's SDE.
Quick Example
A business shows $80,000 in net profit. But the owner also pays himself a $60,000 salary and runs $15,000 in personal car expenses through the business.
SDE = $80,000 + $60,000 + $15,000 = $155,000
That's nearly double what the tax return shows—and it's what buyers are actually paying for.
Why Multiple Years Matter
A single year can be misleading. What if last year was unusually good? Or unusually bad?
Professional valuations use a weighted average across 3-4 years, with more weight given to recent performance:
- Most recent year: 40%
- Year before: 30%
- Two years ago: 20%
- Three years ago: 10%
This approach smooths out anomalies while still emphasizing current trajectory. A business trending upward will show a higher weighted average than one that's declining—even if their most recent year is identical.
Understanding Industry Multiples
Once you have your weighted SDE, you multiply it by an industry-specific multiple. These typically range from 1.5x to 4.0x for small businesses, depending on:
- Industry: Some industries (like recurring-revenue businesses) command higher multiples than others (like restaurants).
- Size: Larger businesses generally get higher multiples—they're seen as more stable.
- Growth trend: Growing businesses are worth more than flat or declining ones.
- Owner involvement: A business that runs without the owner is more valuable than one dependent on them.
- Customer concentration: Diversified revenue is less risky than dependence on a few customers.
These factors can adjust a base multiple by ±5% each, sometimes more.
Why Use Multiple Metrics?
The most accurate valuations don't rely on SDE alone. They combine it with a revenue-based valuation:
- SDE Valuation: Weighted 70%
- Revenue Valuation: Weighted 30%
Why? Because each metric captures something different. SDE shows current profitability. Revenue shows market scale and potential. A business with high revenue but thin margins might have more upside than its SDE suggests. Combining both gives a more complete picture.
The Result: A Range, Not a Single Number
Good valuations provide a range, typically ±7% from the median estimate. This acknowledges the reality that business value isn't an exact science—it depends on market conditions, buyer motivation, negotiation, and timing.
The median represents what you'd expect in a typical transaction with a qualified buyer. The low end might be a quick sale or distressed situation. The high end could happen with competitive bidding or strategic buyers.
What About Formal Appraisals?
Professional business appraisals (from certified appraisers) typically cost $3,000-$10,000+ and take several weeks. They're required for:
- SBA-backed loans
- Legal disputes (divorce, partnership dissolution)
- Estate planning
- IRS matters
For most owners simply exploring a sale, that investment only makes sense after you've confirmed the numbers are in the right ballpark.
Your Next Step
Understanding how business valuation works puts you in control. You're no longer guessing—you have a framework used by professionals every day.
The key is applying it correctly to your specific situation: calculating your SDE across multiple years, using the right industry multiples, and honestly assessing the factors that affect your value.
What's Your Business Actually Worth?
Our valuation tool walks you through this entire process in under 10 minutes. Enter your financials, expense adjustments and real estate value (if applicable) for your business and we'll calculate your weighted SDE, apply industry-specific multiples, and generate your estimated value range and business readiness score for free.
Optional: Purchase and download your comprehensive report ($149) to see the entire breakdown, any identified red/yellow/green flags with immediate action steps, complete business selling process with deal structure tips and more!
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