The Only 2 Business Valuation Methods You Need

Now that I’ve explained the difference between SDE and EBITDA, let’s dive into the two main methods used to value a small to mid-sized company.

Pricing a business is based primarily on its profitability which you can determine in the EBITDA or SDE. Profit is the number one criteria buyers look for when buying a business and the number one factor that buyers use to value a business. 

There are other variables that buyers may consider, but the majority exclusively look for one thing: profit. 

There are two primary methods to value a business:

1. Multiple of EBITDA or SDE: Multiply the EBITDA or SDE of the business by a multiple. Common multiples for mid-sized businesses are three to six times EBITDA. Common multiples for most small businesses are two to four times SDE. 
2. Comparable Sales Approach: This involves researching prices of similar businesses that have sold and then adjusting the value based on any differences between your company and the comparable company.

Profit is the number one criteria buyers look for when buying a business and the number one factor that buyers use to value a business. 

Method 1: Multiple of Earnings (EBITDA or SDE)

Here’s how you can value your business using the multiple of earnings method:

Step 1: Determine the EBITDA or SDE for the previous 12 months or your latest fiscal year. This is called “recasting” or “normalizing” the financial statements. It involves adding the following back to the net profit of your business: depreciation, amortization, owner’s salary, non-cash expenses, non-recurring expenses, and other perks.

Step 2: Multiply your business’s EBITDA or SDE by the multiple.

Example: $1 million EBITDA (Cash Flow) x 4.0 Multiple = $4 million Value of Business

Common Multiples

Here are common current multiples for businesses with less than $5 million in annual revenue:

• Retail Businesses: 2 to 3 times SDE
• Service Businesses: 2 to 3 times SDE
• Food Businesses: 2 to 3 times SDE
• Manufacturing businesses: 3 to 5 or more times SDE
• Wholesale Businesses: 2 to 4 times SDE

Here are common current multiples for businesses with $5 million to $100 million in annual revenue:

• Retail Businesses: 3 to 5 times EBITDA
• Service Businesses: 3 to 5 times EBITDA
• Food Businesses: 3 to 4 times EBITDA
• Manufacturing Businesses: 3 to 6 or more times EBITDA
• Wholesale Businesses: 2 to 5 times EBITDA

Multiples vary with the current economic climate and market conditions. How do you determine the appropriate multiple? Unfortunately, this can only come from experience; however, the guidelines above can be a helpful starting point.

Multiples for Larger Businesses

Most mid-sized businesses are priced at three to six times EBITDA. The multiple varies based primarily on the industry in which a business operates, in addition to several other factors. 

Larger businesses always sell at higher multiples. To demonstrate:

• Business A: SDE of $100,000 per year = 3.0 multiple, or an asking price of $300,000.
• Business B: EBITDA of $5 million per year = 5.0 multiple, or an asking price of $25 million.
• Business C: EBITDA of $100 million per year = 8.0 multiple, or an asking price of $800 million.

The relationship between EBITDA or SDE and multiples is direct. As the EBITDA or SDE of the business increases, so does the multiple. Larger businesses are seen as more valuable by sophisticated investors because they are viewed as more stable, have more professional management teams, and are less dependent on the owner for the business to operate. This is a simple, clear relationship between the size of a company and its multiple that’s demonstrated in the transactional databases and widely accepted by both intermediaries and buyers alike.

Method 2: Comparable Sales Approach

The comparable sales approach is a method for pricing your business based on the prices of similar businesses sold, then making adjustments to account for any differences between your company and the comparable company.

This approach is often difficult to use because the prices of businesses aren’t publicly available. The best source of comparable transactions is from a business broker, M&A intermediary, or business appraiser who has access to private databases. There are several databases sporting comparable business sales. However, the information is sparse or incomplete, so you can’t rely on this data entirely. Collectively, these databases contain approximately 100,000 transactions.

Other Factors to Consider

Value Enhancement

Remember, there are only two direct ways to increase the value of your business:

1. Increase the EBITDA or SDE: There are only two ways to increase the profitability of your business:
   • Reduce expenses.
   • Increase revenues.
2. Increase the Multiple: Multiples are based on several factors, including:
   • Risk: Your multiple is a reflection of how risky a buyer perceives your business to be. To increase your multiple – and your valuation – you should take steps to reduce the risks associated with your business. 
   • Recurring Revenue: Businesses with recurring revenue will attract higher multiples. 
   • Growth Strategy: Buyers will pay higher multiples for companies that have a realistic growth strategy. 

Accounting for Synergies

The valuation methods above do not take into account possible synergies that might be achieved. The value of synergies is impossible to calculate without knowing who the buyer is and having access to their financial statements. The value of synergies is also different for every buyer; therefore, the value of your business can differ substantially depending on who the buyer is.

There are five broad types of synergies: cost savings, revenue enhancement, process improvements, financial engineering such as cheaper access to debt, and tax benefits.

What’s Included in the Price

The price should include all tangible and intangible assets used in the business to generate the cash flow the business produces. This includes all of the equipment and assets required to operate the business on a daily basis. Working capital is generally excluded from the price if the buyer is an individual, while it is included in the price if the buyer is a corporate buyer.

Should inventory be included? This is a common debate among experts. If you have a small business, you can try to get paid for the inventory in addition to the price. It’s going to be negotiated anyway, so ask for it upfront and see what happens.

Pricing a business is based primarily on its profitability. There are other variables that buyers may consider when purchasing a business but the majority exclusively look for profit. When valuing your business, focus on the two methods most buyers use to value a business:

1. Multiple of SDE or EBITDA
2. Comparable Sales

To increase the value of your business, focus on increasing your EBITDA or increasing your multiple.

The value of your business can differ substantially depending on who the buyer is.