How to Calculate What Your Business Is Actually Worth

Sep 15

In Part 1 of this series, we covered why 80% of businesses that go up for sale never sell. One of the biggest reasons was pricing - owners consistently overestimate what their business is worth because they think it’s a multiple of their top-line revenue and nobody ever taught them how valuation actually works.

This is Part 2. We're going to fix that.

I want to be upfront about something: business valuation is not a perfect science. Two buyers looking at the same business can come up with very different numbers depending on their experience, risk tolerance, and what they plan to do with the company after they buy it. What I'm going to walk you through is the framework most small business buyers and brokers use as a starting point - not the final word, but the foundation.

By the end of this you should have a reasonable ballpark for what your business might be worth today, and a clear picture of what variables move that number up or down.

First, forget about revenue

The most common mistake owners make when estimating their business's value is anchoring to top-line revenue. I've heard it dozens of times: "We did $1 million last year, so the business is probably worth $3 million, maybe $4 million?"

That's not how buyers think. Revenue tells a buyer how much money is coming in. It tells them almost nothing about how much money the owner is actually making, how much risk they're taking on, or what they'll be left with after they pay the bills.

The number buyers care about is called Seller's Discretionary Earnings, or SDE. That's where valuation starts.

What is SDE?

SDE stands for Seller's Discretionary Earnings. It's essentially the total financial benefit the current owner receives from the business in a given year. Think of it as the real answer to the question: "If I owned this business, how much would I actually be making?"

To calculate it, you start with your net profit and then "add back" certain expenses. Adding back means taking costs that show up as expenses on your income statement and adding them back into your earnings total (see ‘Simple Example’ below). The logic is simple: some of those expenses are specific to you as the current owner and won't exist for a new owner, so they shouldn't count against the business's true earning power. Here's what you add back:

Here's how it's calculated:

Start with your net profit from the income statement
Add back the owner's salary and any personal benefits run through the business
Add back depreciation and amortization
Add back any one-time or non-recurring expenses that won't exist after the sale (website rebuild, heavy equipment repair, one-time legal fee, etc.)
Add back any personal expenses that were run through the business (non-business expenses run through the business like a personal vehicle, personal travel, family cell phones, etc.)
The result is your SDE

This process is sometimes called "recasting" the financials, and it's standard practice in small business transactions. The goal is to show a buyer what the business actually earns when you strip out everything that's specific to the current owner's situation.

Simple Example:

Let's say your business shows a net profit of $120,000 on your tax return. Here are some common add backs that would apply:

Owner salary: You pay yourself $80,000 a year. A new owner would pay themselves differently, so this gets added back.
Personal vehicle: You run $15,000 in personal vehicle expenses through the business. These are your personal costs, not a business necessity for a new owner.
One-time legal expense: You had a $10,000 legal dispute last year that is resolved and won't repeat. One-time costs that won't recur get added back.
Owner health insurance: You run $8,000 in personal health insurance through the business. A new owner's benefits situation will be different.

Total add backs: $113,000

Your SDE would be approximately $233,000 ($120K net profit + $113K in add backs).

That $233,000 is the number a buyer uses as their starting point, not the $120,000 on your tax return. You can see why understanding this number is critical - the difference between $120,000 and $233,000 is significant when that’s what the multiple, and ultimately value of your business, is based on.

This is why working with an accountant who understands business transactions is important before you go to market. Recasting financials correctly makes a meaningful difference in how your business is presented to buyers.

The multiple: turning SDE into a valuation

Once you have your SDE, you apply a ‘multiple’ to it to get the market rate for your business. The formula is straightforward:

Business Value = SDE x Multiple

If your SDE is $225,000 and the applicable multiple for your industry is 2.5, your business is worth approximately $562,500.

The multiple is where things get more nuanced, because it's not a fixed number. It varies by industry, business size, risk profile, and a dozen other factors. For most small businesses that can be acquired with an SBA loan, multiples typically range from 2x to 5x SDE, with the average sitting somewhere around 2.5x to 3x depending on the industry.

Larger businesses, more profitable businesses, and businesses with stronger fundamentals command higher multiples. Smaller businesses with more risk, owner dependency, or inconsistent financials get lower multiples.

What moves your multiple up or down

This is the part most owners don't know about, and it's where the real work of building business value happens. Your multiple is not fixed - it's a reflection of how risky and how transferable your business looks to a buyer.

Things that increase your multiple

Low owner dependency - the business runs well without you in every decision or day-to-day operations
Recurring or contracted revenue - predictable cash flow reduces buyer risk
Diversified customer base - no single customer represents more than 15% to 20% of revenue
Documented systems and processes - a buyer can see how the business operates without asking you, and can step into the system you’ve created
Strong, tenured team - key employees are likely to stay after the transition
Clean, consistent financials - three years or more of records that are easy to verify
Identified growth opportunities - buyers want something they can grow, not just maintain
Seller willingness to stay on during transition - reduces perceived risk for the buyer and ensures a smooth transition
Flexible deal structure - sellers open to ‘earnouts’ or seller financing are significantly more attractive to buyers

Things that decrease your multiple

High owner dependency - key relationships, knowledge, or decisions sit with you personally
Customer concentration - one or two customers make up the majority of revenue
Inconsistent or declining revenue - buyers price uncertainty heavily
Messy financials - anything that's hard to verify creates doubt, and doubt is enough of a reason to walk away from a deal
Industry headwinds - a business in a declining market will get a lower multiple
Key person risk - if a critical employee left tomorrow and the business would suffer, that's a huge risk
No systems or documentation - the business lives in people's heads so everything collapses if those people leave
Deferred maintenance or capital needs - buyers factor in what they'll need to spend after closing

Most businesses have a mix of factors that bring the multiple up and down. The goal isn't perfection, it's making sure the factors working against you are addressed before you go to market.

How to find comparable multiples for your industry

The best data on what businesses actually sell for comes from transaction databases, most of which require payment to access (PeerComps, BizComps, etc.). If you're not ready to pay for that level of detail yet, here are two practical starting points:

BizBuySell: The largest online marketplace for small businesses. They publish quarterly reports on transaction data including median revenue multiples and cash flow multiples by industry. It's free and publicly available. Keep in mind the best businesses often sell off-market and don't show up here, so the multiples may skew slightly low. Still a very useful benchmark.

Current listings in your industry: Look at what similar businesses are listed for on BizBuySell and other marketplaces. Back into the implied multiple by dividing the asking price by the stated cash flow. This gives you a real-world sense of where sellers are pricing similar businesses, even if those asking prices don't always reflect what they actually sell for.

When you're closer to actually going to market, a business broker or M&A advisor with experience in your industry will have access to actual transaction comps. That's the most reliable data you can get.

A note on asset-based and revenue-based valuations

SDE multiples are the most common valuation method for small, owner-operated businesses. But they're not the only method.

Some businesses, particularly those with significant physical assets like equipment, real estate, or inventory, may be valued partially on an asset basis. A business with $500,000 in equipment might have a floor value near that number even if the SDE multiple suggests something lower.

Some larger businesses, particularly those above $5 million in revenue, may be valued on EBITDA multiples rather than SDE. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a similar concept to SDE but excludes the owner's salary add-back, which makes more sense for businesses that would run with a professional management team rather than a hands-on owner.

For most small businesses in the SBA-financeable range, SDE is the right starting point.

Running the numbers on your own business

Here's a simple exercise you can do today to get a rough sense of where you stand:

Pull your last three years of tax returns or income statements
Calculate your net profit for each year (if this isn’t something you can easily pull, you need help changing that ASAP)
Add back your owner's salary, personal benefits, and any one-time expenses
Average the three years to get a ‘normalized SDE’ (buyers typically look at a weighted average, with more recent years carrying more weight)
Find the average SDE multiple for your industry using one of the transaction comp databases or BizBuySell data
Multiply your SDE by that multiple
That's your rough starting point

It won't be exact. A real valuation done by a professional will be more precise and will account for factors this exercise can't. But it'll give you a number to work with and, more importantly, it'll tell you whether you're in the right ballpark or significantly off from what you're expecting.

Most owners who do this exercise for the first time are surprised - sometimes pleasantly, sometimes not. Either way, knowing the real number is better than guessing. So do it, even if it’s scary.

What to do with this information

If you run these numbers and the value is lower than you hoped, that's actually useful information. It means you have time to do something about it. The factors that drive your multiple up are things you can work on - owner dependency, systems and processes, customer concentration, documentation, bookkeeping and financial clarity. None of them change overnight, but all of them are fixable with time and focus.

That's exactly what Part 3 of this series covers. We'll go through the specific steps you can take right now to make your business worth more, regardless of when you plan to sell.

Coming up in this series:

Part 3 covers the specific steps you can take right now to make your business more valuable and more attractive to buyers - a practical playbook regardless of your exit timeline.

The Disconnect Series

Part 1: 80% of Businesses Listed For Sale, Never Sell. Here's Why.

Part 2: How to Calculate What Your Business Is Actually Worth (you are here)

Part 3: What You Can Do Right Now to Make Your Business Worth More (coming soon)

Robert Frary

Business owner, operator, and advisor based in Austin, TX. I help founder-led companies build more valuable businesses and navigate what comes next. robertfrary.com

Robert Frary