How to Value a Small Business (SDE, EBITDA and Multiples)

A Price Is a Bet on Future Profit

No buyer pays for your hours, your trucks or your years in business on their own. They pay for cash the company will keep producing under new ownership, and they discount it for anything that looks shaky.

That is why two companies with the same revenue can sell for very different prices. Valuation starts with one question: what does this business really earn, and how sure can a stranger be about it?

Step One: Recast the Books

Your tax return is built to keep taxes low. A buyer needs the opposite view: what the business would have earned if it were run for profit and nothing else.

Recasting means going through each year line by line and adjusting for costs that will not carry over to a new owner. Common examples include:

• Your own salary, payroll taxes and benefits
• A family member on payroll who does little work
• A personal vehicle, phone or travel run through the company
• A one time legal bill, storm repair or equipment write off
• Rent paid to yourself above or below what the market would charge

Every adjustment needs a paper trail. Buyers and their lenders will test each one, and an add back you cannot prove tends to cost you credibility on the rest.

Most brokers recast three years plus the trailing twelve months. A steady or rising line across those periods is worth more than one great year.

Seller's Discretionary Earnings

SDE is the total benefit one full time owner gets from the business. Start with pretax profit, then add back interest, depreciation, amortization, the owner's pay and the other adjustments above.

SDE fits companies where the buyer will likely step in and run things day to day. It answers a simple question: if I buy this and work in it, how much is there for me and my debt payments?

EBITDA

EBITDA is earnings before interest, taxes, depreciation and amortization. The big difference from SDE is that it assumes a paid manager runs the company, so a market salary for that role stays in as a cost.

Larger buyers think in EBITDA. Private equity groups and competitors buying their way into Tarrant County usually plan to install a manager, not work the front counter themselves.

For a company somewhere around $1 million to a few million in revenue, a broker may calculate both figures. Which one the market uses depends on who is likely to buy.

Where the Multiple Comes From

Once earnings are set, value is usually that figure times a multiple. The multiple is not pulled from the air. Brokers look at recorded sales of similar companies, adjusted for size, industry and risk.

Here is a made up example to show the math. A company with $600,000 of SDE and a multiple of 3 would be valued around $1.8 million. A multiple of 3.5 would put it near $2.1 million.

That half point swing is worth $300,000 in this example. That is why most of the work in a sale goes into earning a better multiple, not just reporting a higher profit.

Multiples vary by industry and by year, and published averages can mislead. Treat any rule of thumb you read online as a rough starting point, never as your number.

What Moves the Multiple

Buyers raise or lower their multiple based on how risky the earnings look. A few factors come up again and again in North Texas deals:

• Customer concentration, such as a machine shop doing most of its work for one aerospace prime
• Recurring revenue, like service agreements or contracts that renew each year
• A manager or lead tech who can run the place when you are gone
• Clean, timely financials that match the bank statements
• Equipment age and whether big replacements are coming due
• A lease with enough years left, and a landlord willing to assign it

Industry matters too. Buyers look at construction, trucking and oilfield service companies through the lens of cycles, so steady results across good and bad years earn a premium.

Other Ways to Value a Company

Earnings multiples are the main tool for profitable companies, but not the only one. Brokers sometimes cross check with other methods.

An asset approach adds up equipment, inventory and receivables. It sets a floor for heavy equipment businesses, and it can be the main method when profits are thin.

A discounted cash flow model projects future earnings and converts them to today's dollars. It shows up more in larger deals, where a buyer's analysts build their own forecast anyway.

A broker opinion of value blends these with current buyer demand. A certified appraisal is a separate, more formal product, and you may need one for estate, partner or lending reasons.

The Value Is Not the Check

A headline price and the cash you receive are different things. Two offers at the same number can be worth very different amounts once you read the terms.

Look at how much is paid at closing, how much rides on a seller note or earnout, and how the working capital adjustment is set. Whether it is an asset or stock sale also changes your tax bill.

Lenders shape value as well. Many buyers finance through SBA 7(a) loans, which the SBA caps at $5 million, so the loan size and your cash flow can limit what those buyers can pay.

Then there are the costs of the sale itself, from your attorney and CPA to the broker. Our guide to what business brokers charge shows how that part is figured.

Getting Started

You do not need a spreadsheet to begin. Our partner can give you a free, confidential read on value as part of a business valuation, with no obligation.

If you plan to sell in a few years, see our page on exit planning for ways to raise the multiple first. Or use the valuation form above, or call (817) 555-0142.