How to value a small business: the whole process

A defensible valuation is not one clever calculation. It is a sequence: gather the statements, recast the earnings, size the company, apply more than one method, reconcile the indications, and write down why. Skip a step and the number at the end is an opinion with no support under it. This guide walks the whole sequence in order.

Step 1: Gather the financial statements

Start with three to five years of income statements and balance sheets, plus the matching tax returns. Tax returns matter because small-company books are often kept for tax purposes, and the two rarely agree. Where they disagree, you want to know why before a buyer or an opposing expert asks. Pull the current year's interim figures too, and the detail behind the big lines: the general ledger for officer compensation, rent, auto, travel, and any account with a family member's name near it.

While you are collecting paper, collect context. Who are the top five customers and what share of revenue does each carry? What does the lease say about assignment? Which employees would a buyer need to keep? None of this is arithmetic yet, but all of it shows up in the arithmetic later.

Step 2: Recast the earnings

Reported profit is almost never the number a buyer receives. Owners run personal vehicles, above-market salaries, family payroll, and one-time expenses through the business, and every one of those depresses the earnings that actually transfer. Recasting adds them back to produce seller's discretionary earnings, or SDE: pre-tax profit plus one working owner's compensation, interest, depreciation, and the non-operating and personal items.

This is the single highest-leverage step in the process. At the multiples typical of small companies, every dollar of legitimate add-back is worth two to three dollars of value, and every dollar of illegitimate add-back is a credibility problem waiting for scrutiny. Recasting deserves its own discipline, and it has its own guide:financial statement recasting, explained.

Step 3: Size the company, honestly

Size drives multiples more than almost any operating factor, and it is the thing owners most often get wrong by comparison shopping in the wrong aisle. In reported small-business transactions over the trailing five years, the average business sold for about 2.58 times SDE, with sector averages running from roughly 2.0 to 3.3. The median sale price in that dataset was $340,000. Meanwhile, professionally managed companies in the lower middle market trade at 4 to 6 times EBITDA and sometimes higher.

Those are different markets with different buyers. A $300,000-SDE machine shop is not entitled to a private equity multiple, and telling the owner it is helps nobody. Locate the company on the size curve first; every judgment after this one depends on it.

Step 4: Apply more than one method

There are three recognized approaches — income, market, and asset — and a handful of methods under each. For an owner-operated company, the usual core set is amultiple of discretionary earnings,capitalized earnings, andmarket comparables, with adiscounted cash flow when the future will not resemble the past andadjusted book value as the floor beneath everything.

Why several? Because each method has a blind spot. An earnings multiple cannot see a signed contract that doubles next year's revenue. A DCF can see it, but a DCF built on a hopeful forecast is fiction with decimal places. Comparables reflect what buyers actually paid but stumble on comparability. When independent methods land near each other, that convergence is the evidence. When they disagree, the disagreement tells you which assumption to go re-examine. Choosing among them is its own judgment; seehow to choose a valuation method.

Step 5: Reconcile the indications

Four methods produce four numbers. Reconciliation is the step where you assign each indication a weight and state a reason. Not a formula — a reason. "Market comps weighted 10% because the comp set is thin and deal terms are unreported" is a sentence a reviewer can argue with, which is exactly what makes it credible. Weights that appear from nowhere are the first thing an opposing expert attacks.

Watch the spread, not just the weighted average. If the indications run from $650,000 to $950,000, the honest conclusion acknowledges that range. An outlier usually means one method's inputs are wrong, and finding out which is more useful than averaging over it.

Step 6: Document the work

A number without a paper trail does not survive contact with a lender, a buyer's accountant, or a courtroom. The finished file should show the recasting schedule with the basis for each add-back, the inputs to each method, the weight and reason for each indication, and the conclusion with its effective date and standard of value. If you cannot reconstruct the number from the document a year later, it was not documented.

This is most of what you pay for when a full appraisal runs $5,000 to $15,000: not the arithmetic, the support. It is also what ExitSight is built to produce — every worksheet you complete becomes a table in the report, with your stated reasoning attached.

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