How to Determine a Small Business Valuation: 5 Keys for 2025

Business valuation is a crucial process that determines the economic value of a business, arguably the most important step of any transaction. Whether you’re planning to sell your business, attract investors, or plan for succession, understanding how valuations work is essential. This guide will explain the various methods used to value a business and key factors influencing the final number.

1. Why a Small Business Valuation Matters

A. Determining Fair Market Value

Small business valuations help establish the fair market value of a company, which is the price that a willing buyer would pay and a willing seller would accept under normal conditions. Valuations are used in several scenarios, including business sales, mergers and acquisitions, raising capital, and for legal matters like divorce or estate planning. Banks and other financiers will also care about valuation as they assess risk.

B. Planning for Growth and Strategy

Valuations can also provide valuable insights into the strengths and weaknesses of a business, offering owners a deeper understanding of what drives value. This knowledge can be used to make strategic decisions, improve profitability, or prepare for future exits.

 2. Methods of Small Business Valuation

A. Income Approach

The income approach focuses on the earning potential of a business. It measures a company’s ability to generate profits and cash flow, making it one of the most commonly used methods to value a small business. This approach is particularly useful for established businesses with consistent revenue streams. Below are the primary methods used under the income approach:

• • Revenue Multiples: Valuing a business based on its revenue is common in industries with strong growth potential or for businesses that might not yet be profitable. Revenue multiples are typically used when profits are either minimal or secondary to growth. The revenue multiple approach involves applying an industry-standard multiple to a company’s total revenue. For example, businesses in high-growth industries like technology may be valued at 2-3 times or more than their annual revenue.

• • EBITDA Multiples: Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a standard metric used to measure a business’s financial health. The EBITDA multiple is calculated by applying an industry-standard multiplier to the company’s EBITDA. This method focuses on core operating profitability, excluding non-operational and non-cash expenses, providing a clearer view of the business’s true earnings power. The EBITDA multiple can vary by industry but generally falls within 3-6 times EBITDA, depending on growth potential, risk, and market conditions.

• Seller’s Discretionary Earnings (SDE): SDE is another widely used method, particularly for small and owner-operated businesses. It adjusts EBITDA by adding back discretionary expenses—those costs that benefit the owner but are not essential to the business’s operations, such as personal vehicle use, above-market salary, or family member compensation. SDE reflects the total financial benefit to an owner-operator and is often used by buyers looking to replace the existing owner. The SDE multiple, like EBITDA, can range between 2-5 times, depending on the business’s size, industry, and risk profile.

B. Market Approach

The market approach uses comparisons to similar businesses that have been sold recently to determine value. It’s analogous to how real estate appraisers value homes by comparing them to similar sales in the neighborhood. This method requires access to databases of comparable sales, which may be limited.

C. Asset-Based Approach

This method values a business based on the total value of its assets, minus liabilities. It’s commonly used for companies with significant physical assets (e.g., manufacturing or equipment businesses). There are two types of asset-based valuations:

• Going Concern: This method values the assets as if the business will continue operating, reflecting their current value in use.
• Liquidation Value: This method calculates the value of the business’s assets if it were to be sold off and liquidated, usually resulting in a lower valuation.

 3. Key Factors That Influence Business Valuation

A. Industry Trends

The state of the industry plays a significant role in determining a business’s value. Growing industries with high demand and future potential (such as technology or healthcare) often see higher valuations compared to industries facing decline or disruption.

B. Revenue and Profitability

A business’s revenue and profitability are critical in determining its value. Consistent, growing revenues and healthy profit margins are attractive to buyers and investors. When evaluating profitability, key metrics include EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and net income.

C. Customer Base and Market Position

Businesses with a loyal customer base, strong brand recognition, and a competitive position in the market are generally valued higher. Customer contracts, subscription models, and recurring revenue streams add to the attractiveness of a business.

D. Risk Factors

Higher-risk businesses typically receive lower valuations. Risk factors include dependency on a small number of clients, legal issues, market volatility, or significant reliance on the owner’s personal involvement. A well-documented succession plan and diversified client base help mitigate these risks.

 4. Common Multiples Used in Business Valuation

A. Earnings Multiples

Earnings multiples, such as SDE or EBITDA multiples, are commonly used to value businesses. The multiple reflects industry norms and the perceived risk of the business. For example, businesses in stable industries may be valued at 4-6 times their EBITDA, while businesses in riskier or newer industries might have lower multiples.

B. Revenue Multiples

Revenue multiples are often used for startups and high-growth companies that may not yet be profitable. A common multiple for tech startups is 2-3 times revenue, depending on growth potential and market conditions.

5. Get an Outside Perspective

Business valuation is both an art and a science, requiring expertise in finance, industry knowledge, and economic factors. Hiring a professional  or using proper tools (Unbroker provides both) can increase the changes of an objective and accurate assessment of your business’s worth. Valuation experts use standardized methods and can help you interpret the numbers to make informed decisions, adding credibility to any acquisition marketing and financing activities.

Conclusion

Understanding business valuation is essential whether you are selling your business, seeking investment, or planning for the future. The value of your business depends on several factors, including its profitability, industry trends, and market position. By knowing the valuation methods and engaging experts when needed, you can make strategic decisions that enhance your business’s value and ensure the best possible outcome in a sale or investment scenario.