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How a Business Is Valued

A first look at earnings, multiples, and what really sets the price a buyer pays.

Selling a business is not like selling a house. There is no public record of comparable sales, and the same company can be worth wildly different amounts to different buyers. Before you can think about price, you need a rough mental model of how buyers do the math. This page gives you that model. The deeper mechanics live in the linked concept pages.

You Are Selling Future Cash, Not Past Sales​

Start with what a buyer is actually purchasing. They are not paying for your revenue history, your market share, or how hard you worked. They are paying for the cash the business will throw off after they own it.

Burlingham puts it bluntly:

"What you're really selling is future cash flow."

Burlingham, Finish Big, ch. 3

And:

"Cash is king because it's the only thing you can spend. People buy businesses so that they'll eventually have more of it."

Burlingham, Finish Big, ch. 3

Everything else in valuation is a way of estimating that future cash and pricing the risk that it does not show up. (See What You Are Really Selling: Future Cash Flow.)

Earnings Times a Multiple​

For most non-tech businesses, price comes from a simple formula: take a measure of earnings and apply a multiple. McDannell sums up the whole exercise:

"A company is worth what someone is willing to pay for."

McDannell, Get Acquired, ch. 2

The earnings figure depends on the size of the business. Larger companies are valued on EBITDA (earnings before interest, taxes, depreciation, and amortization), a rough proxy for free cash flow. Smaller, owner-run businesses are valued on SDE (seller's discretionary earnings), which adds the owner's pay and perks back in, since a new owner could keep that money. McDannell treats SDE as the right metric for sub-$1M owner-operated firms. (See EBITDA Multiples and Seller's Discretionary Earnings (SDE).)

Before applying any multiple, you restate the books. Owner-specific and one-time costs (a personal car, a one-time rebrand, the owner's above-market salary) get added back, because the next owner will not carry them. This is normalization, and it raises the earnings number the multiple is applied to. (See Add-Backs and Normalization.)

The multiple itself varies by industry and by how risky the cash flow looks. A business with recurring revenue, low customer concentration, and a team that runs without the owner earns a higher multiple. A business that depends on the owner for everything earns a lower one, or no buyers at all.

Snider compresses the whole exercise into one line, where cash (recasted EBITDA) times a multiple (tangible and intangible assets) equals value:

"CASH (recasted EBITDA) × MULTIPLE (tangible and intangible assets) = VALUE"

Snider, Walking to Destiny, ch. 6

He adds that every business trades inside a range of value set by the private capital market, a range the owner does not get to choose. What the owner does control is placement within that range, which is driven by intangible capital and by how much risk the business carries:

"Although you can't control the range, you can control where you place in the range."

Snider, Walking to Destiny, ch. 6

That gap between where you sit today and the top of your range is The Value Gap, and the intangible capital that moves you up the range is captured in The Four Cs of Intangible Capital.

The Same Business Has More Than One Price​

Here is the part owners find counterintuitive. There is no single "right" value. Warrillow's whole framing is that:

"Value Is in the Eye of the Acquirer."

Warrillow, The Art of Selling Your Business, ch. 1

A strategic buyer who can plug your customers into their existing sales machine will pay more than a financial buyer chasing a return, who will pay more than an individual buying a job. The art is finding the buyer who values your business most, then giving them the story to justify it:

"The art of selling your business is getting someone to value something they cannot touch. In essence, they are buying a story about what your business could be in their hands."

Warrillow, The Art of Selling Your Business, ch. 1

(See Types of Buyers and Value Is in the Eye of the Acquirer.)

Three Ways Buyers Actually Run the Numbers​

Warrillow (ch. 12) lays out the methods a buyer or advisor uses to land on a figure:

  • Asset-based: the fair-market value of hard assets. A floor, not a ceiling, for a profitable business. Anything paid above it is goodwill.
  • Comparables: what similar companies recently sold for. Useful, but small private companies trade at deep discounts to large public ones, so benchmarking against a public multiple leads to disappointment.
  • Discounted cash flow (DCF): projecting future cash and discounting it to today's value. (See Discounted Cash Flow (DCF).)

In practice the earnings-times-a-multiple shorthand and comparables do most of the work for businesses under $50M. DCF and asset value sit in the background as cross-checks.

A final, critical distinction: what your business is worth on the open market is not the same as what you need it to be worth to walk away comfortably. Keep those two numbers separate. (See Want Number vs Need Number.)

Further Reading​

Sources: McDannell, Get Acquired ch.3; Warrillow, The Art of Selling Your Business ch.1, ch.12; Burlingham, Finish Big ch.3; Snider, Walking to Destiny, ch. 6.