How to Value a Business: The Market Approach

If you're a small business owner and you've ever Googled "how much is my business worth," you've probably seen a bunch of generic answers. Things like "2-4 times earnings," "use an online calculator," or "speak to a business broker."

The problem with these answers is that none of them actually help you understand what's really going on.

Intro

So I'm doing a four-part series that's going to fix that. I'm going to walk you through the three approaches that every business broker, appraiser, and buyer uses to value a small business — as well as a fourth approach that most brokers won't talk about.

• Part 1 (this video): The Market Approach — the most commonly used method. If you're only going to learn one, make sure it's this one.
• Parts 2 and 3: The Income Approach and the Asset Approach — the other two standard valuation methods.
• Part 4: The Returns Approach — the one most brokers won't talk about, but that every sophisticated buyer is using when they look at your business. Stay tuned for that.

I'm Ed, a business broker and the founder of Sundance Financial. We help small business owners sell their companies all over the US. If you like this video, hit subscribe so you don't miss any of our updates.

With that, let's get into it.

How The Market Approach Works

The Market Approach works exactly like a real estate appraisal. You look at what similar businesses have actually sold for recently, and use that data to estimate how much yours is worth.

Here's how it works in practice. Business brokers look at thousands of recent business sales to identify businesses similar to yours — meaning similar industry, similar size, and similar geography. They then use that information to calculate what's called a valuation multiple.

The Valuation Multiple

A valuation multiple works just like the "value per square foot" metric you'd see in real estate — except instead of square footage, we look at business earnings.

Put another way, the valuation multiple is simply the ratio of a business's value to the earnings it generates. For business owners, this multiple answers the question:

For every dollar of earnings my business produces, how much are buyers generally willing to pay?

If the valuation multiple is 3x earnings, then for every $1 of earnings the business generates, a buyer would be willing to pay $3 on average.

Which Earnings Metric?

One question I often get is: which earnings metric should we use? There are a few to consider — revenue, EBITDA, and SDE, just to name some of the common ones.

For small businesses doing under $5 million in sales — where the owner is still heavily involved in day-to-day operations — the standard metric is Seller's Discretionary Earnings (SDE).

I'll drop a link to a more detailed video explaining SDE in the description, but essentially you can think of it as your business's pre-tax profit plus your salary plus any personal expenses you run through the business (insurance, travel, meals, entertainment, etc.). SDE gives a buyer a sense of the total economic benefit that would accrue to them if they were to purchase your business.

I'll also be posting a video on how to use your tax returns to calculate SDE — make sure to subscribe so you don't miss it.

Worked Example

Let's make this a little more concrete. Suppose you own a landscaping company, and your SDE — after adding back your salary and personal expenses — is about $300,000 per year.

You look at similar landscaping businesses that have sold recently, and you find they've traded at about 2.5x SDE.

$300,000 × 2.5 = $750,000

That's your estimated market value.

Multiples Vary By Industry

That 2.5x multiple isn't just a magic number — it can vary widely by industry. For example:

• Restaurants: ~2.3x
• Medical practices: ~2.6x
• Machine shops: ~3.7x

I'll put a link to a full table with valuation multiples by industry in the description.

The point is that the Market Approach is grounded in real data. It's what buyers have actually paid in recent transactions, and it gives you actual evidence of what the market will value your business at. That's exactly why I like it: it's practical, simple, and evidence-based. On top of that, it's what buyers and their lenders are most likely going to use to assess your business.

Wrap-Up

So there you have it — that's the Market Approach. Like I said, if you only learn one valuation method, make sure this is the one.

In Part 2, I'll walk you through the Income Approach, also known as a Discounted Cash Flow analysis. Using this method, we look at your business's future earnings potential — as opposed to what other similar businesses have sold for in the past — to determine value.

If you found this video helpful, do me a favor and hit subscribe. I'm building out this channel to give small business owners the straight, practical talk on valuing, preparing, and listing their businesses for sale.

You can also check out my video explaining SDE by clicking here. And if you're seriously thinking about selling your business and want to talk through your specific situation, I offer a free, no-obligation consultation — link in the description.

Again, I'm Ed from Sundance Financial. I'll see you in Part 2.