Most owners find out what their business is worth at the worst possible moment: when a buyer makes an offer, a partner wants out, or a lender asks. By then the numbers that drive the price are already set. A business is not worth what it cost to build or what the owner needs to retire. It is worth what a well-informed buyer would pay for the cash it will produce, adjusted for how risky that cash looks. This guide explains how that number is worked out, and what you can do about it in the years before you need it.
Key Takeaways
- Most valuations aim at fair market value: the price a willing buyer and a willing seller would agree on, neither under pressure and both knowing the relevant facts.
- There are three approaches: income (what the business will earn), market (what similar businesses sold for), and asset (what its assets are worth, net of debts).
- Small businesses are usually priced on a multiple of seller’s discretionary earnings (SDE); larger ones on a multiple of EBITDA. Both start from clean, adjusted financial statements.
- Value rises with recurring revenue, a spread of customers and a business that runs without the owner, and falls with the opposite.
- Tax filings, SBA-financed sales and legal disputes generally need a formal valuation from an independent, credentialed appraiser. A sale or planning decision can start from a valuation analysis.
What “value” actually means
The IRS’s long-standing definition, from Revenue Ruling 59-60, is the one most valuations start from. Fair market value is the price at which property would change hands between a willing buyer and a willing seller, when neither is under any compulsion to buy or sell and both have reasonable knowledge of the relevant facts.
That definition matters because the same company can carry different values for different purposes. A strategic buyer who can cut shared costs may pay more than fair market value. A minority stake is usually worth less per share than a controlling one. A valuation for an estate tax return has to follow IRS standards, while one for your own planning does not. Knowing why you want a number is the first step to getting a useful one.
The three approaches
| Approach | The question it asks | Best suited to |
|---|---|---|
| Income | What cash will this business produce in future, and what is that worth today given the risk? | Profitable service and operating businesses |
| Market | What have buyers paid for similar businesses, measured as a multiple of earnings or revenue? | Businesses with comparable sales data in their industry |
| Asset | What are the business’s assets worth at market value, less its liabilities? | Holding companies, asset-heavy or loss-making businesses |
A careful valuation usually runs more than one approach and reconciles them. If an income approach says $2 million and an asset approach says $400,000, the gap is the goodwill a buyer is being asked to pay for, and it had better be backed by durable earnings.
SDE, EBITDA, and why the books have to be adjusted
Buyers do not price your reported net income. They price what the business would earn under a new owner, so the financial statements are normalized first:
- Seller’s discretionary earnings (SDE) adds back the owner’s own salary and benefits, interest, depreciation and amortization, and one-time or personal expenses run through the business. It shows what one owner-operator would take home. It is the usual measure for smaller, owner-run businesses.
- EBITDA (earnings before interest, taxes, depreciation and amortization) assumes the business pays a market salary to whoever runs it. It is the usual measure once a business has a management team and the buyer is an investor rather than an operator.
Common adjustments include a family member on payroll who does not work in the business, a one-off legal settlement, rent paid to the owner above or below market, and personal vehicles or travel. Every add-back has to be documented. An undocumented add-back is the first thing a buyer will strike from the number, and it costs you the multiple on top.
This is why valuation starts with bookkeeping. Three years of accurate, consistently prepared financial statements are the raw material. If the books are behind or mix personal and business spending, the valuation is only as good as the guesswork used to clean them up.
What raises value, and what cuts it
| Buyers pay more for | Buyers discount for |
|---|---|
| Recurring or contracted revenue | One-off, project-by-project revenue |
| Many customers, none dominant | One customer making up a large share of sales |
| A team and documented processes that run without the owner | Relationships and know-how that sit only with the owner |
| Steady or rising margins over three or more years | Volatile or declining earnings |
| Clean, timely financial statements | Late books, unexplained adjustments, commingled spending |
| Enough working capital to operate after closing | A business that needs cash injected on day one |
Almost everything in the right-hand column can be fixed, but not quickly. Owners who start two or three years before a sale have time to reduce customer concentration, hand off relationships, and build a clean earnings history. Owners who start when an offer arrives mostly negotiate over the discount.
When you need a formal valuation
For your own planning, or to decide whether an offer is fair, a valuation analysis built from your financial statements is often enough. Some situations call for a formal report from an independent, credentialed appraiser:
- Gift and estate tax. Transfers of business interests to family members or through an estate are valued under IRS standards. Revenue Ruling 59-60 lists eight factors an appraiser must weigh: the nature and history of the business, the economic and industry outlook, book value and financial condition, earning capacity, dividend-paying capacity, goodwill, prior sales of the stock and the size of the block, and the market prices of comparable public companies.
- SBA-financed sales. Lenders financing the purchase of a business under SBA programs generally require an independent valuation from a qualified appraiser, and those rules are being tightened. Your lender will tell you what it needs.
- Divorce, partner disputes and litigation, where the number has to hold up in front of a court.
- Buy-sell agreements between owners, which should say how and how often value is set.
Recognized business-appraisal credentials include the ASA (American Society of Appraisers), ABV, CVA and CBA. Ask any appraiser which standards their report follows and whether they have valued businesses in your industry and size range.
How to prepare, starting now
- Get three years of clean financial statements, closed monthly and reconciled, with business and personal spending separated.
- Keep a running list of add-backs, with the documents that support each one.
- Track the numbers buyers look at: margins, revenue by customer, recurring revenue and working capital. Our guide to financial KPIs covers the formulas.
- Reduce owner dependence: document processes and introduce key clients to the rest of the team.
- Put contracts in writing, including customer agreements, leases and key employee arrangements.
- Choose your entity and tax structure deliberately. How a sale is structured can matter as much as the price. See LLC vs S-Corp in Texas.
How Ledger Tree helps
Ledger Tree works with privately held Dallas–Fort Worth businesses, mostly in the $1 million to $20 million revenue range. We prepare and normalize the financial statements a valuation depends on, run valuation analysis for sale and acquisition decisions as part of our M&A advisory work, and coordinate with an independent credentialed appraiser when a formal report is required. If you are thinking about selling in the next few years, or have an offer in hand, call us at (214) 807-2440.
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Frequently Asked Questions
How is a small business valued?
Usually by more than one of three approaches: the income approach, based on the cash the business is expected to produce and its risk; the market approach, based on what buyers paid for similar businesses; and the asset approach, based on the market value of its assets less its liabilities. The results are then reconciled into a single conclusion.
What is the difference between SDE and EBITDA?
Seller’s discretionary earnings adds the owner’s own salary and benefits back to earnings, showing what one owner-operator would take home, and is used for smaller owner-run businesses. EBITDA assumes a market salary is paid to whoever runs the business and is used for larger companies with a management team.
What factors affect what my business is worth?
The size and stability of earnings, how much revenue is recurring, how concentrated the customer base is, how dependent the business is on the owner, the quality and timeliness of the financial statements, growth, and the working capital the business needs to operate.
When do I need a formal business valuation?
Generally for gift and estate tax filings, business purchases financed through SBA loans, divorce and other legal disputes, and buy-sell agreements between owners. In those cases the valuation should come from an independent, credentialed appraiser. For planning or weighing an offer, a valuation analysis is often enough.
How often should I value my business?
Many owners benefit from an estimate every year or two, and whenever something significant changes, such as an offer, a new partner, a large acquisition or an estate plan update. A regular number lets you see whether the things that drive value are moving in the right direction.
How long does it take to prepare a business for sale?
Ideally two to three years. That is long enough to build a clean earnings history, reduce reliance on the owner and on any single customer, and document the adjustments a buyer will scrutinize. Starting when an offer arrives mostly leaves room to negotiate over the discount.
Sources: Internal Revenue Service, Revenue Ruling 59-60 (definition of fair market value and the eight valuation factors); U.S. Small Business Administration, SOP 50 10 lender requirements for change-of-ownership valuations; American Society of Appraisers and other credentialing bodies for the ASA, ABV, CVA and CBA designations. Retrieved 2026-09-26. SBA valuation rules change periodically; confirm current requirements with your lender.