Accurate valuation is essential when buying or selling a business.
It establishes a fair price, builds trust, and strengthens credibility during negotiations. Buyers and sellers need a clear framework to walk through the valuation process—based strictly on the business’s financials, rather than throwing out arbitrary numbers.
Trust and credibility are vital to successful transactions.
Another reason accurate valuation matters is loan supportability.
If you overpay for a business that can't be supported by its cash flow, you might struggle to qualify for a loan or sustain the business post-acquisition.
Understanding how to value a business correctly is key to reducing risk.
When it comes to valuing a target business, there are three main methods:
This method bases a company’s value on its projected future cash flows, discounted to present value. It considers the risk and time value of money.
This is a preferred method in SMB acquisitions.
It involves comparing the target business to similar companies that have sold recently.
For example, if you're acquiring an HVAC company with $3 million in revenue and 15% margins, analyzing similar sold businesses gives you a reasonable valuation benchmark.
Comparable analysis makes it easier to communicate value to sellers who may not understand complex valuation models.
If the business is asset-heavy, you can value it based on the value of its assets.
Asset-based lending institutions often use this approach.
For a detailed walkthrough of everything covered in this article, watch the full webinar Valuation Deep Dive: How to Determine the Right Price:
Market comparables serve as practical benchmarks for fair valuations, particularly in lower and middle-market transactions.
They allow buyers to quickly assess fair market prices for businesses based on size, industry, and financial performance.
Looking at transactions from 1990 through July 2024, clear industry trends emerge:
High Multiples:
Information Technology: 8.8x earnings
Reflects strong growth and scalability.
Mid-Tier Stability:
Manufacturing: 5.4x EBITDA
Food & Beverage Processing: 5x EBITDA
Lower Multiples:
Restaurants and Construction
Higher operational risks and thinner margins.
Larger businesses command higher multiples.
For example, a company with $5 million EBITDA may fetch a higher multiple than one with $500,000 EBITDA.
Larger businesses attract larger players willing to pay a premium.
A study analyzing businesses with $3–$15 million in net sales over the last two years revealed:
Most businesses trade between 2.5x–5x earnings.
14,415 verified transactions analyzed.
Businesses with stronger margins (10–15%) align closely with these multiples.
If a business asks outside these typical multiples, it must demonstrate exceptional quality or growth potential.
BizBuySell shows that smaller businesses—$100K to $500K enterprise value—tend to trade closer to 2x earnings.
This reflects the trend that smaller businesses command lower multiples due to size, risk, and marketability.
When valuing a business, several factors play a critical role:
Historical Financial Performance:
SBA lenders focus heavily on historical numbers, not projections.
Industry Trends and Competitive Landscape:
Declining industries or heightened competition can lower valuations.
Operational Factors:
New contracts, customer concentration, or market shifts must be factored into the value.
Common valuation multiples include:
Enterprise Value / EBITDA
Price / Earnings
Enterprise Value / Sales
Regardless of which is used, the results should align closely.
Whether valuing by EBITDA multiples or percentages of sales, conclusions should be reasonably similar.
The valuation process typically follows these steps:
Understand Client Needs
Gather Financial and Market Data
Normalize and Adjust Financial Statements
Peer Company Benchmarking
Apply Multiple Valuation Methods
Create and Present a Valuation Report
Normalization is critical: one-time events and non-recurring expenses must be adjusted to reflect the business’s true, ongoing earning power.
What EBITDA range should buyers target?
Most SMB acquisitions fall between $500K–$2M EBITDA.
What's the difference between EBITDA and SDE?
EBITDA excludes owner compensation.
SDE (Seller Discretionary Earnings) adds back owner salaries and perks.
SDE multiples are lower but arrive at roughly the same valuation when calculated correctly.
How do buyers and sellers agree on multiples?
Often multiples (e.g., 4x adjusted EBITDA) are defined in the LOI, subject to confirmation via due diligence.
Overreliance on a single method: Always cross-verify using multiple approaches.
Ignoring industry trends: Regulatory, competitive, or growth factors heavily impact valuation.
Failing to normalize: Non-recurring or one-time events must be properly adjusted.
Working capital mistakes: Not addressing working capital levels in LOIs can create major surprises at closing.
Top buyers conduct scenario analyses:
Base Case: Revenue remains steady.
Downside Case: 15% revenue decline post-acquisition.
Upside Case: 10–15% revenue growth.
Scenario analysis shows if a business can still support debt service under various conditions, helping reduce buyer risk.
For a more comprehensive look at the different valuation approaches used in mergers and acquisitions, this guide from Valutico breaks down seven essential methods—ranging from market-based to income-based models—and explains when to use each depending on deal context.
While determining a company’s value is essential, buyers must also factor in the true acquisition cost. According to DealRoom, the final purchase price often extends beyond the initial valuation. Legal fees, integration costs, consultant charges, and earn-outs can materially shift the total amount a buyer pays. These additional elements should be budgeted into the total deal model when evaluating affordability and ROI.
There’s no one-size-fits-all valuation formula. As Investopedia explains, six common methods can be applied depending on the nature of the business:
Market Capitalization
Times Revenue Method
Earnings Multiplier
Discounted Cash Flow (DCF)
Book Value
Liquidation Value
Use multiple valuation methods.
Rely on actual market data and comparables.
Normalize financials carefully.
Align buyer and seller expectations early.
Incorporate scenario analysis into your acquisition model.
Contact us today to learn how we can support your next deal.