How to Value a Small Business: Multiples, SDE, and What Sellers Get Wrong

Most small businesses sell at 2–4× SDE — but the range is enormous. Here's how to find where a specific business actually lands.

The Two Earnings Metrics You Need to Know

SDE — Seller's Discretionary Earnings

Used for businesses where the owner is actively working in the business. It's EBITDA plus the owner's compensation (salary + benefits + perks). The logic: a new owner-operator would capture all of this cash.

SDE = Net Income + Owner Salary + Owner Benefits + Depreciation + Amortization + Interest + One-time expenses

EBITDA — Earnings Before Interest, Taxes, Depreciation, and Amortization

Used for larger businesses (typically $1M+ revenue) where the owner is more executive than operator. If you'd hire a manager to run day-to-day operations, EBITDA is the cleaner metric.

For most small business acquisitions under $2M purchase price, SDE is the standard. Above $5M, EBITDA takes over. The $2-5M range often uses both with contextual judgments.

Typical Valuation Multiples by Business Size

What Actually Moves the Multiple

The table above is a starting point, not a conclusion. Specific characteristics will push a business toward the high or low end of its range — sometimes dramatically.

Pushes multiple higher:

- Revenue is recurring (subscriptions, contracts, maintenance agreements)

- Owner is not essential to operations — business runs without them

- Revenue is diversified across many customers (no single client > 15%)

- Business is in a growing market or defensible niche

- Clean books, audited financials, no surprises

- Multiple years of consistent growth

- Transferable relationships and processes (documented systems, trained staff)

Pushes multiple lower:

- Owner is the business (clients follow the person, not the entity)

- Revenue concentrated in 1-3 customers

- Declining revenue trend

- Messy books, cash transactions, add-back disputes

- Industry in structural decline

- Equipment is old and will need replacing

- Lease expires soon with uncertain renewal

Understanding Add-backs — and Why They're Contested

Add-backs are expenses the seller claims a new owner wouldn't incur — thus increasing SDE. Some are legitimate. Some are not. Disputes over add-backs are the most common source of valuation disagreements.

Legitimate add-backs:

- Owner salary (standard)

- Owner's personal vehicle run through the business

- Depreciation and amortization

- One-time legal fees (a specific lawsuit, not ongoing)

- Personal travel clearly unrelated to the business

Contested add-backs:

- "One-time" marketing spend that happens every year

- Family member salaries for work that was actually necessary

- Repairs that are actually deferred maintenance (capital expenditure in disguise)

- "Owner discretionary" expenses that are ambiguously defined

When reviewing a CIM, build your own add-back schedule and defend each line. Lenders will do the same — and they'll be more skeptical than you.

Sellers consistently overvalue based on potential ("this business could do 2x revenue with the right owner") rather than documented performance. Buyers pay for what's already there, not what's possible. Potential gets you 0.0x; documented systems and recurring revenue get you premiums.

The Three Valuation Methods

1. Income Approach (most common)

Multiple × SDE or EBITDA. This is what most brokers use and what most buyers should use as their primary method. The multiple reflects the risk and desirability of the cash flow stream.

2. Asset Approach (floor value)

What would you get if you liquidated everything? Sum up fair market value of all assets (equipment, inventory, receivables) minus liabilities. For most service businesses, this produces a number far below market value. It's a floor, not a ceiling.

3. Market Comps (validation)

What have similar businesses sold for recently? BizBuySell, Pratt's Stats, and your broker network can provide comps. This is useful for sanity-checking an income-approach valuation, but comps are often limited in quality for very small businesses.

How to Negotiate From a Valuation Position

The most effective negotiation approach isn't to dispute the seller's number — it's to show your work.

Build a written valuation memo:

- Your adjusted SDE (with your own add-back schedule)

- Your chosen multiple and the factors driving it up or down

- Your DSCR at the asking price (and at what price DSCR reaches 1.25)

- Comparable sales if you have them

Present this not as an attack on the seller's number, but as the math you're required to present to your lender. Sellers can be emotional about price; lenders can't be. Shifting the conversation to financing constraints ("my bank requires a 1.25 DSCR, which means the price needs to be $X") depersonalizes the negotiation.