Guide
How a private business is valued
Four methods, what each one measures, and where each stops being reliable. None of them produces a price: they produce a range that a buyer and a seller then argue about.
Methods
The four core methodologies
Which method applies depends less on preference than on the size and shape of the business. A one-owner operation and a company with a management layer are not valued the same way, and applying the wrong basis will be obvious to any buyer who reads the accounts.
Seller's discretionary earnings (SDE)
Small owner-operated businessesAdds the owner's salary, benefits and non-essential expenses back to net income before a multiple is applied. It measures the total financial benefit available to a single working owner, which is what a buyer of that kind of business is actually acquiring.
EBITDA multiple
Mid-market and aboveEarnings before interest, taxes, depreciation and amortisation, used as a proxy for cash flow. Because it strips out capital structure and tax position, it allows companies financed and domiciled differently to be compared on operating performance alone. It is the more reliable basis where a business has genuine management in place.
Revenue multiple
High-growth and pre-profitUsed where current earnings do not describe the business, typically software and other high-growth models, and future potential carries the value instead. It is a materially cruder basis: it ignores how much of that revenue reaches the bottom line, and the ranges it produces vary widely by sector and growth rate.
Discounted cash flow (DCF)
Intrinsic valuationProjects future cash flows and discounts them back to present value. It is the only method that values the business on its own forecast rather than on what others paid, which makes it the most rigorous and the most sensitive to its own assumptions, small changes to the discount rate or terminal growth move the answer a long way.
Market evidence
Using comparable transactions
Comparable data ("comps") means the prices actually paid for similar businesses. It is the only method grounded in observed behaviour rather than in a forecast, which makes it the reality check on everything else. It is also the method most easily abused, because the comparison set is chosen by whoever is presenting the number.
- Identify true peers. Same specific sector, similar size by revenue and earnings, similar business model and geography. A sector average across every size band is not a comparable.
- Work in ranges. Read the spread of revenue and EBITDA multiples across the set, not the mean. The spread is the information; the mean hides it.
- Adjust for the differences. No two businesses are identical. Move up or down the range on growth rate, margin, customer concentration, owner dependence and the strength of the management team relative to the comparison set.
A comparable set records deals that were reported. Undisclosed private sales cannot appear in it, so treat any distribution drawn from it as evidence about the disclosing subset rather than about the whole market.
Further reading
Related notes
SDE vs. EBITDA: choosing the right metric
Which profitability measure fits your company, and what changes when you switch.
The art of the comp
Finding a defensible comparison set and applying it without flattering the answer.
How market conditions move valuations
Why the same business is worth a different amount in a different rate environment.
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