Valuation

What valuation answers

Valuation answers three different questions that are often confused. What is it worth? is an estimate of value based on cash flows and risk. What will it sell for? is a market question about what buyers pay. What can I pay? is a financing question about what debt and equity can support and still earn a return. In a small acquisition the third question usually binds first: a lender will not fund beyond the cash flow can carry. Good analysis states all three and explains the gaps. Numbers on this page are illustrative unless a source is named.

See also: modeling fundamentals (DCF mechanics), LBO modeling, M&A basics, the glossary, and the community guides.

Enterprise value to equity value

Enterprise value (EV)  = value of the operating business to all capital providers
Equity value           = EV - debt (bank loans, SBA loans, seller notes, capital leases)
                            - debt-like items (unpaid taxes, deferred revenue obligations, earnout
                              liabilities, unfunded owner loans)
                            + cash not needed to run the business

Purchase price on the term sheet is usually quoted on a "cash-free, debt-free"
basis with a normal level of working capital delivered.

Multiples of EBITDA or SDE produce enterprise value. When you compare quotes, confirm whether the price includes working capital, real estate, vehicles, and any cash; deals with the same headline price can differ by 10% once these are counted.

Choosing the earnings measure

BizBuySell's definition of seller's discretionary earnings starts with pre-tax net profit and adds back one owner's compensation, benefits, depreciation and amortization, interest, and personal or one-time costs. EBITDA, by contrast, assumes the business pays a professional manager. Always convert before you compare: if the seller's SDE is $1.16M and a replacement manager costs $160K loaded, EBITDA is $1.0M. A 3.0x multiple of SDE is then 3.5x EBITDA. The lender and your investors will look at EBITDA.

Comparable companies

The idea: companies with similar risk and growth trade at similar multiples. Steps:

1. Pick 5 to 15 similar public companies by industry, size, growth and margin. Use SEC EDGAR to read each business description and find the numbers.
2. For each, compute enterprise value (market capitalization plus debt minus cash) and trailing EBITDA.
3. Divide to get EV/EBITDA, and compute the median (less affected by outliers than the mean).
4. Apply a range around the median to the target's EBITDA.
5. Adjust for what differs: size, liquidity, concentration, growth, margin.

Hypothetical example (invented companies, $ millions):

Applied to a target with $1.0M of EBITDA that is 6.5x or $6.5M. A small private company is less liquid, usually less diversified and dependent on fewer people, so analysts apply a discount. If you apply an illustrative 30% discount, the value is $4.55M. The size of the discount is judgment; show a range and explain it. For small businesses, public comps are context only: the companies are far larger, so precedent transactions carry more weight.

Precedent transactions

The idea: what did buyers pay for similar businesses? This is the main method for small companies. Sources and their limits:

• GF Data. Private equity-sponsored deals from $10M to $500M of enterprise value. In 2024 the average was 7.2x trailing EBITDA overall and 6.4x for the $10M to $25M tier. Subscription for detail; highlights are free.
• Stanford GSB Search Fund Study. The median search fund purchase price was $14.4M at 7.0x EBITDA for the 2022 to 2023 acquisitions, with a 27% median EBITDA margin and 25% median growth.
• IBBA Market Pulse and BizBuySell Insight Report. Broker-reported data on very small deals, useful for sentiment and median sizes.
• SEC filings. Public acquirers sometimes disclose purchase price, revenue and EBITDA of small acquisitions in 8-Ks and notes to financial statements.
• Your own network. Brokers, lenders and accountants know what deals cleared this year.

Adjust for date (rates and sentiment move), size, growth, margin, customer concentration, and structure: a 5.0x price with a large seller note is not the same as 5.0x all cash. Put each comparable in a table with the source, date and what the price includes.

Discounted cash flow

Covered with a numeric example on modeling fundamentals. The key points for valuation: forecast unlevered free cash flow; pick a discount rate that matches risk; compute a terminal value; discount; subtract debt. Because the terminal value is often most of the answer (62.8% in that example), run a table of discount rate against terminal growth and present the range.

Building a discount rate for a small company

Cost of equity = risk-free rate + beta x equity risk premium + size premium + company-specific premium
Cost of debt   = the rate the lender quotes (SBA 7(a) caps at Prime + 3.0% above $350K)
WACC           = E/(D+E) x cost of equity + D/(D+E) x cost of debt x (1 - tax rate)

Illustration: cost of equity 18%, pre-tax cost of debt 9.75%, 60% equity / 40% debt,
tax 21% (C corporation): 0.6 x 18% + 0.4 x 9.75% x 0.79 = 13.9%.

Aswath Damodaran's free datasets (NYU Stern) provide industry betas, risk premiums and cost-of-capital inputs, updated each January. Treat the size and company-specific premiums as judgment and show how value changes if they move.

Ability to pay: the LBO view

Work backward from what a lender will fund. Illustration with invented inputs:

1. Cash flow available for debt service (EBITDA less capex less owner tax distributions): $850,000.
2. Required coverage: 1.25x for initial acquisitions under SOP 50 10 8.1. Maximum annual debt service = 850,000 / 1.25 = $680,000.
3. Loan terms: 9.75% and 10 years. Annual payment per dollar of loan = 0.1569 (from the payment formula), so the loan supported = 680,000 / 0.1569 = about $4.33M.
4. SBA requires at least 10% equity injection of total project cost, so total uses = 4.33M / 0.90 = about $4.81M.
5. Subtract fees ($300K) and working capital cash ($250K): price = about $4.26M, or 4.3x EBITDA of $1.0M.

If the seller wants 5.0x, you have a gap of about $0.7M. Options: a seller note (on full standby, it counts toward the injection but not toward debt service), an earnout, more equity, a lower price, or walking away. This arithmetic often explains why prices in a market cluster at a particular multiple.

Adjusting for a small private company

• Key person risk. If the owner holds the customer relationships, value falls unless the transition is structured (earnout, seller note, long handover).
• Customer concentration. Quantify: lost revenue times contribution margin against debt service. See the downside on the LBO page.
• Quality of earnings. SOP 50 10 8.1 requires a lender-ordered QoE for initial acquisitions of $3M or more; it must reconcile statements, tax returns and bank data, and the lender must use the QoE earnings in the coverage test.
• Lack of marketability. A private company cannot be sold in a day; valuation professionals apply a discount. The amount is a judgment, so show your range.
• Real estate. Separate the business from the building. Value the lease at market rent. SBA real estate loans can run up to 25 years; goodwill and working capital loans up to 10.
• Structure. Seller notes, earnouts and rollover change the effective price. Compare on a present-value basis.
• Growth. Stanford's median search acquisition grew 25%; a flat business deserves a lower multiple.

Putting it together

Professionals show a "football field": a bar for each method showing its range, then a proposed price range. A small deal version, with invented numbers:

The overlap, $4.0M to $4.3M, is the defensible range. Offer inside it, with structure (a modest seller note and an earnout on the large customer) to bridge the gap to the ask.

Benchmarks with sources

• GF Data, 2024: 7.2x all deals, 6.4x for $10M to $25M enterprise value; senior debt averaged 2.5x EBITDA for platform deals over 2024; 63.6% of deals used rollover equity.
• Stanford 2024: median search purchase price $14.4M, 7.0x EBITDA, 27% margin, 25% growth, 34 employees.
• SBA: maximum loan $5M; equity injection 10% of total project cost; coverage 1.25:1 for initial acquisitions; term up to 10 years for goodwill and working capital; rate cap Prime + 3.0% over $350K.
• Prime rate 7.00% on October 22, 2026 (Federal Reserve H.15).

These describe different populations and years, so compare with care; see industry reports for how to read them.

Traps

• Applying a large-company multiple to a $1M EBITDA business without a size adjustment.
• Mixing SDE and EBITDA multiples.
• Forgetting working capital, real estate or vehicles in the price.
• Using a DCF terminal growth rate near the discount rate, which explodes the value.
• Valuing a forecast the seller made instead of normalized history.
• Ignoring how the price is paid: structure changes value.
• Treating one broker's listing multiple as a market.

Practice

1. Build the comparable table above for a real public industry using EDGAR 10-Ks. Compare the median to the 6.4x GF Data tier and write why they differ.
2. Work the ability-to-pay arithmetic for three different EBITDA levels and see where the $5M loan cap binds.
3. Value one real small business listing three ways and write a half-page memo with the range.
4. Answer the valuation questions in the interview bank out loud.

Worked example: a precedent table

Six hypothetical small-business transactions (invented) in the same industry:

Sorted, the multiples are 3.8, 4.0, 4.2, 4.4, 4.5, 5.1x; the median is 4.3x. A target with $1.0M of EBITDA, recurring contracts and one large customer might be placed between deals 1 and 3: about 4.0x to 4.3x, or $4.0M to $4.3M. The deals with more cash at close and larger size sit at the high end, which is why you adjust for structure and size, not just average.

The grid shows why a QoE that cuts EBITDA by 10% matters: at 4.5x it removes $450K of value. Price moves by the multiple times the earnings change.

Valuation memo template

1. Company and request (two lines)
2. Earnings basis: reported, normalized EBITDA, SDE, with the bridge
3. Approach 1: precedents (table, median, adjustments, range)
4. Approach 2: DCF (assumptions, discount rate range, value range)
5. Approach 3: ability to pay (debt capacity at 1.25x, equity, price)
6. Football field: ranges and the overlap
7. Risks that move value: concentration, owner dependence, quality of earnings
8. Recommendation: offer range, structure (cash, note, earnout), conditions
9. What would change my view
10. Sources: every number linked

Keep it to two pages. Lenders and investors read the first paragraph and the football field.

From SDE to price: a conversion walk

A broker lists a landscaping company at SDE of $900K and asks $2.7M (3.0x SDE). Invented numbers, to show the steps a buyer takes.

The ask of $2.7M is 3.0x SDE, 3.6x the $750,000 EBITDA, 3.9x the $690,000 adjusted EBITDA and 4.2x the $650,000 after excess capex. A buyer who compares to precedents quoted on EBITDA must use the EBITDA basis. The lender will see the supported number too: under SOP 50 10 8.1 the lender must use the QoE earnings in the debt service test for acquisitions of $3M or more; this deal is under that threshold, but a lender will still test the numbers against tax returns.

When the company owns the building

1. Charge the operating business a market rent so EBITDA reflects what a tenant would pay. Suppose market rent is $120,000 a year.
2. Value the operating business on EBITDA after rent.
3. Value the building separately, from an appraisal or from rent divided by a capitalization rate. At an illustrative 8% rate, $120,000 of rent suggests $1.5M. Get a real appraisal; the SOP sets appraisal standards for real estate in a change of ownership.
4. Add the two to get total value, and check the financing: real estate loans can run up to 25 years while goodwill and working capital loans are limited to 10 (SOP Appendix 17), so the structure changes debt service.
5. Decide whether to buy the building or lease it. A lease from the seller is common and keeps the equity check smaller.

Sources

• GF Data, Highlights Fourth Quarter 2024
• Stanford GSB, 2024 Search Fund Study
• SBA SOP 50 10 8.1 (Appendix 15, Appendix 17, interest rate chart)
• Federal Reserve H.15 (prime rate)
• BizBuySell: Seller's discretionary earnings
• Damodaran Online: data
• SEC: Accessing EDGAR data
• IRS Publication 542 (21% corporate rate)