How to value a small business you want to buy

You found a business you like, and the listing says $1.2 million. Is that a fair price, a steal, or wishful thinking on the broker's part? Valuing a small business you want to buy comes down to three questions. None of them require a finance degree, but you do need to ask them in order.

Let's walk through it the way you'd do it at the kitchen table.

Step 1: Find the real earnings (SDE) behind the listed profit

The profit line on a listing is a marketing number. What you want is SDE (Seller's Discretionary Earnings), which is the business's pre-tax profit, plus the owner's salary and perks, plus one-time expenses that won't continue under you. It answers the main question for a buyer who plans to run the business: how much cash does this thing put in one working owner's pocket in a year?

SDE is built from add-backs, and add-backs are where sellers get creative. The owner's $80,000 salary is a legitimate add-back, because you'll replace the owner. A "one-time" legal expense that shows up three years running is not one-time, and $30,000 of "personal travel" that went to customer visits is a cost you'll have too. Before you trust any SDE figure, work through the add-backs yourself (see how to tell a legit add-back from an inflated one), because every dollar of inflated add-back costs you three to four dollars of purchase price once it gets multiplied.

Step 2: Apply a multiple and know what moves it

Once you trust the SDE, the market shorthand is a multiple. As a screening rule of thumb, owner-operated small businesses tend to change hands around 3x to 4x SDE. A business that runs without the owner, with a real manager and documented systems, can justify more because the buyer gets the income without taking on the owner's job. Make sure any multiple you're comparing is built on SDE. A multiple quoted against EBITDA instead of SDE describes a different number, and mixing the two up is an easy way to misread a price by six figures. For what a fair multiple looks like by deal size, see what's a fair multiple for a small business.

What pushes a business toward the top of the range:

• It runs without the seller. If every customer relationship lives in the owner's head, you'll be putting money down to take over the owner's job.
• Revenue that repeats. Service contracts and recurring customers beat one-off projects.
• A spread-out customer base. If one client is 40% of revenue, losing that one client can erase the value.
• Clean books. The tax returns match the P&L. If the seller says the "real" numbers are different from the tax returns, believe the tax returns.

What drags a business toward the bottom of the range, or below it, is the opposite of that list, plus declining revenue, deferred maintenance, and a lease that expires in eight months. Many of those overlap with the red flags that sink deals.

Be careful with any tool or broker that quotes you a precise "market value" for a Main Street business. A plumbing company in Gilbert, Arizona doesn't have a stock price you can look up. A multiple range is a screen that tells you whether an asking price deserves a closer look or some suspicion. It is not an appraisal.

Step 3: Run the lender math that decides the deal

Most valuation articles skip this step, but it ends more deals than any multiple does. It asks one question: will a bank finance this price?

Most small-business acquisitions in the US are financed with an SBA 7(a) loan. Your lender will take the business's annual cash flow and divide it by the annual loan payments. That ratio is the debt service coverage ratio (DSCR). SBA lenders typically underwrite to a floor of about 1.15 (at least $1.15 of cash flow for every $1.00 of loan payment) and like to see room above it. They also measure it after setting aside a real salary for whoever runs the business, and they fold in your personal debt.

That's why the lender math is the real valuation test. A price can sit inside the 3x to 4x band and still fail, because at that price, with your down payment, the loan payments eat up the cash flow. When that happens, the price is wrong no matter what the multiple says. You can run this check on any listing in about a minute with the free does-it-pencil check.

A worked example

Say a heating-and-air business is listed at $850,000:

That deal screens well: the multiple is reasonable and the cash flow covers the debt with margin. Now the real work starts: verifying that $295,000 is real, analyzing the business end to end (see how to analyze a business before you buy it), and checking for the red flags that kill deals. A good screen tells you the deal is worth your next twenty hours. The decision to buy comes after that work.

What if the asking price fails the math?

Then you've learned something valuable, and it didn't cost much. You have three honest options: negotiate the price down to where the math works, restructure the deal (a seller note on standby can change the coverage picture), or walk away. Don't talk yourself into it. If the multiple looks fine and the coverage ratio fails, trust the coverage ratio, because it's arithmetic.

Remember the professionals' role here. A good SBA lender will tell you for free whether a loan can work, so talk to one as soon as a deal looks real. A CPA should check the seller's numbers before you bet your savings on them. Scope gets you to both conversations prepared, with the paperwork already sorted, so the hours you pay for go to their judgment.

FAQ

What is a business with $300K of SDE worth?

As a screen, it's worth roughly $900K to $1.2M if it's owner-operated (3x to 4x SDE), adjusted for how well it runs without the owner, how concentrated the customers are, and how clean the books are. Whether any specific price is right depends on whether the cash flow finances it.

Is the asking price usually negotiable?

Usually, yes. Listings are priced to leave room. If you can show with the lender math that the cash flow doesn't cover the loan at this price, you can negotiate from evidence.

Should I use SDE or EBITDA?

For an owner-operated small business, use SDE. EBITDA assumes the business keeps paying someone to manage it. SDE assumes you are the manager. Using the wrong one misprices the deal by exactly one owner's salary.

Do online valuation calculators work?

They're fine as screens if they show their work. If a tool gives you one precise number and shows no assumptions, trust it about as much as a seller who won't show tax returns.

Do I still need a professional valuation?

For most Main Street deals, a formal appraisal happens inside the SBA loan process anyway, because the lender orders one. Your job before that is the screen: real SDE, a sane multiple, and a price that can be financed.

Educational content, not financial, legal, or tax advice for your situation. Confirm specifics with your own CPA and attorney.