What Is Your Business Worth?
Small businesses commonly sell for a multiple of their yearly owner earnings — often 2–4x for small service firms, more for recurring revenue and less owner dependence.
Buyers pay for predictability: contracts, diversified customers, documented processes and a business that runs without you.
The same profit can be worth very different prices. $300K of owner earnings might sell for $600K or $1.5M depending on risk and transferability.
Even if you never sell, running your business as if a buyer were watching forces good habits.
A critical step in valuation is choosing and defining the earnings metric. The two most common for small businesses are Seller's Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). SDE starts with pre-tax profit and adds back interest, depreciation, amortization, any discretionary or personal expenses the owner runs through the business, AND one owner's market-rate compensation. EBITDA is similar but it does NOT add back the owner's compensation. For this reason, SDE is almost always a higher number than EBITDA for the same small business, and consequently, valuation multiples applied to SDE are typically lower than those applied to EBITDA. You cannot compare an SDE multiple to an EBITDA multiple without adjusting for this key difference.
When calculating Seller's Discretionary Earnings (SDE), buyers and sellers must agree on 'add-backs'. These are expenses on the profit and loss statement that are for the owner's benefit and are not essential for business operations. A new owner would not incur these costs. Common, defensible add-backs include the owner's salary (or the portion above a market-rate replacement), personal health insurance, personal vehicle expenses, and non-recurring expenses like a one-time legal settlement. To be considered 'defensible', you must have clear documentation (receipts, credit card statements) proving the expense was not a core business necessity.
Net income is the profit remaining after all recorded expenses, including interest and taxes. EBITDA adds back interest, taxes, depreciation and amortization to net income. SDE also adds back one owner's compensation and documented discretionary expenses, so it is usually the highest of these three earnings measures for a small, owner-operated business.
You, imagine you wanted to take a six-month sabbatical from your business. The systems, team, and documented processes you'd need to build for that to be possible are the very things that make your business more valuable and transferable to a buyer.
Learning objective
Estimate a value range using normalized earnings and explicit transfer risks.
Understand the mechanism
Define the earnings metric before applying a multiple. SDE, EBITDA and free cash flow are not interchangeable. Owner add-backs require evidence, and replacing the owner's work can reduce transferable earnings.
Multiples depend on industry, size, growth, customer concentration, financing and market conditions. A generic 2–4x range is an illustration, not a reliable appraisal. Compare relevant transactions and understand whether quoted prices include debt, cash and working capital.
Put it to work
Build an earnings bridge from reported profit to defensible normalized earnings. Separate enterprise value from equity proceeds by accounting for debt, cash and adjustments. Include fees and tax when estimating what an owner retains.
Improve transferability with documented processes, durable contracts and a capable team. Verify that contracts can actually transfer; recurring billing alone is not enough.
Worked example
- 1
Assume defensible normalized earnings of $300,000 and illustrative multiples of 2.5x to 3.5x.
- 2
Enterprise value range is $750,000 to $1,050,000.
- 3
At midpoint $900,000, subtract $200,000 debt and add $50,000 eligible cash: illustrative equity value $750,000 before fees, tax and deal adjustments.
A valuation is a range built on assumptions, not a price you are entitled to receive.
Your practice lab
Earnings $200k, multiple 3x, debt $150k and eligible cash $20k. Calculate enterprise and equity values, then name two reasons a buyer might pay less.
Personal scratchpad · not graded or saved
The Tale of Two Consulting Firms
Clara runs 'Clara Consulting'. She is a brilliant strategist and the firm's only consultant. All client relationships are with her personally. She brings in $250,000 in owner earnings per year, but if she leaves, the business has no clients and no one to do the work. The firm has value, but it is tied entirely to her continued presence.
Next door is 'Momentum Strategy Group'. They also generate $250,000 in owner earnings for their founder. However, they have a team of three consultants, a documented sales process, and client contracts held by the company, not individuals. The founder oversees strategy but isn't the primary contact for most clients.
While both firms have identical earnings, 'Momentum Strategy Group' would sell for a significantly higher multiple. A buyer is purchasing a predictable system for generating profit, not just hiring a talented individual. Its value is transferable and less dependent on a single person.
A business that can run without its founder is fundamentally more valuable than one that can't, even if their profits are the same.
Illustrative example — names and figures are composites for teaching.
Identify the top 2-3 risks in your business that would lower its valuation multiple (e.g., owner dependence, customer concentration, undocumented processes). For each risk, list one concrete action you can take in the next 90 days to reduce it.
Example: Risk 1: Owner Dependence (I am the only one who handles sales). Action: Document my entire sales process in a shared drive and start training my manager to handle inbound leads. Risk 2: Customer Concentration (Client ABC is 40% of revenue). Action: Launch a focused outreach campaign to acquire 3-5 new mid-size clients in an adjacent industry.
Go deeper — outside resources
- U.S. Small Business Administration — learning hub · U.S. Small Business Administration
- MyMoney.gov — learning hub · MyMoney.gov
Key ideas
- Value ≈ earnings × a multiple
- Predictability raises the multiple
- Owner-dependence lowers it
Try it: Estimate a rough value for a business you know: earnings × 2–4. What would raise the multiple?
Quick check
1. Which raises a business's multiple most?
2. $300K earnings at a 3x multiple is worth about…
3. A business has $150,000 in SDE, $50,000 in debt, and $10,000 in cash. Using a 2.5x multiple, what is the estimated equity value before fees?
4. For a typical small, owner-operated business, which earnings metric will usually be the higher number?
5. Which of the following is a common and defensible 'add-back' when normalizing earnings?
6. A potential buyer is valuing your business. Which factor is most likely to *decrease* the multiple they are willing to pay?