Business valuation methods, explained

Ask three people how to value a business and you'll get three answers. Usually that's because they're describing different methods without saying so. The good news: there aren't dozens of approaches to learn. There are five, and most deals lean hard on the first one.

One note on the numbers below before we get into the examples. Every figure here is a round-number illustration picked to make the math obvious. They're examples, not market data or quotes. A real multiple for your business depends on your industry, size, growth, and risk. You can pull an indicative range from our business valuation calculator in a few seconds.

1. Market approach (earnings multiple)

How it works. You take a measure of annual profit and multiply it by a number, the multiple, that reflects what buyers pay for a dollar of profit in your industry. For owner-operated businesses, profit is measured as Seller's Discretionary Earnings (SDE): net profit plus the owner's salary and one-time or personal add-backs. For larger businesses with a management team, you measure it as EBITDA (earnings before interest, taxes, depreciation, and amortization).

When it's used. This is the default. Most small and lower-middle-market deals price this way because the multiple is grounded in what comparable businesses are actually selling for.

Pros and cons. It's fast, it's intuitive, and it tracks the real market. The catch: the multiple does all the heavy lifting, so pick the wrong one and the whole number is off. SDE multiples run lower than EBITDA multiples because SDE already includes the owner's pay. Comparing the two without saying which you mean is a common mistake.

Example. A business produces $1M in EBITDA. Comparable companies in its sector trade around 5x. Estimated value: $1M × 5 = $5M. Say it were a smaller, owner-run shop with $400K in SDE in a sector that trades at 3x. The math would be $400K × 3 = $1.2M. (Illustrative figures.)

2. Income approach (discounted cash flow)

How it works. A discounted cash flow, or DCF, values a business by its future. You project the cash the business will throw off over the next several years, then "discount" those future dollars back to what they're worth today. A dollar five years out is worth less than a dollar now. The discount rate reflects how risky those projections are.

When it's used. Larger businesses, high-growth companies, and situations where the future looks very different from the past: a new contract ramping up, a product line scaling, a recent investment about to pay off. Finance teams also reach for it when they want a number built from the ground up rather than borrowed from comparables.

Pros and cons. On paper it's the most rigorous method, and the only one that genuinely accounts for growth. But it's only as good as the assumptions feeding it. Nudge the growth rate or the discount rate a little and the value swings a lot. For a stable, mature small business, that precision is often false precision.

Example. A company is expected to generate $500K of free cash flow a year, growing slowly, and you discount those flows at 20% to reflect the risk. As a rough illustration, that stream might value the business around $2.5M to $3M in today's dollars. (Illustrative. The real figure depends entirely on the growth and discount assumptions.)

3. Asset-based approach

How it works. You add up what the business owns and subtract what it owes. Equipment, inventory, real estate, and receivables on one side; debts and liabilities on the other. What's left is the net asset value.

When it's used. Asset-heavy businesses (manufacturing, equipment rental, real-estate-backed operations), holding companies, and distressed or wind-down situations where the business isn't generating much profit. It's also useful as a floor. A profitable business should be worth more than its assets, so if an earnings-based number comes in below asset value, something is off.

Pros and cons. For tangible assets, it's concrete and hard to argue with. The downside: it ignores everything that makes a healthy business valuable, like brand, customer relationships, recurring revenue, and the team. For a profitable service business, asset value badly understates the real price.

Example. A small manufacturer owns $1.5M in equipment and inventory and carries $400K in debt. Net asset value: $1.5M − $400K = $1.1M. If the same business earns strong profits, a buyer would likely pay more than that on an earnings basis. The $1.1M is the floor, not the ceiling. (Illustrative figures.)

4. Rule-of-thumb (industry formulas)

How it works. Many industries have a shorthand: a quick formula passed around among buyers and brokers, often expressed as a multiple of revenue or a per-unit figure. "Roughly one times annual revenue" or "a set amount per recurring customer" are the kinds of shortcuts you'll hear.

When it's used. As a back-of-the-envelope sanity check, especially early on or when financials are thin. They're handy for a gut check on whether a more careful number is in the right ballpark.

Pros and cons. Fast and easy, and they carry some real-world wisdom about how a sector trades. But they're blunt. A rule of thumb can't tell a well-run business from a struggling one in the same industry, so it should never be the final word.

Example. If a rule of thumb in a sector is "about one times annual revenue," a business with $2M in revenue lands near $2M. Useful as a quick check. But if that business has fat margins and is growing fast, an earnings-based valuation could land well above it. (Illustrative figures.)

5. Comparable transactions

How it works. You look at what similar businesses recently sold for and price by analogy. It's a close cousin of the market approach, but instead of applying a generic industry multiple, you anchor to actual completed deals (same industry, similar size, similar profile) and back into the multiple they implied.

When it's used. Whenever good comparable data exists. In active sectors with frequent deal flow, recent transactions are the strongest evidence of what a buyer will actually pay. That's why advisors lean on them heavily when setting an asking price.

Pros and cons. It reflects the real market better than any formula because it's built from real prices. The catch is data. Truly comparable private deals are hard to find, terms are often confidential, and no two businesses are identical, so adjustments are always needed.

Example. Three similar businesses in a sector recently sold at an average of about 4.5x EBITDA. A comparable business earning $800K in EBITDA would price near $800K × 4.5 = $3.6M, before adjusting for differences in growth and risk. (Illustrative figures.)

Which method fits which business size

You rarely use just one. In practice, the size and type of the business decides which method leads and which serve as cross-checks.

Business	Lead method	Cross-checks
Owner-operated, under ~$1M earnings	SDE multiple	Rule-of-thumb, asset floor
Lower-middle-market, $1M–$5M+ EBITDA	EBITDA multiple	Comparable transactions, DCF
High-growth / changing trajectory	DCF	EBITDA multiple, comps
Asset-heavy or distressed	Asset-based	Earnings multiple if profitable

The pattern holds across the board. Smaller businesses lean on multiples and rules of thumb. Larger and faster-growing ones bring in DCF and comparable transactions. Asset value sets the floor underneath all of them. The most credible valuation is the one where two or three methods point to roughly the same place.

Want to go deeper on the numbers? See our breakdown of EBITDA & SDE multiples by industry, the practical guide to how much your business is worth, or the full walkthrough of selling your business.