Business valuation formula with SDE, EBITDA and multiples explained

There is no single official business valuation formula for a private company, but there is one that buyers, brokers and lenders use far more than any other: earnings multiplied by a market multiple. The hard part is not the multiplication. It is choosing the right earnings figure (SDE or EBITDA), adjusting it so it reflects what a new owner would actually earn, and picking a multiple that matches the size, risk and industry of the business. This guide explains each piece in plain terms and then runs a full calculation on a company with 1.8 M USD in revenue, so you can see where the numbers come from and where they are most often wrong.

What the business valuation formula looks like in practice

For most privately held companies that sell for under roughly 5 M USD, the working formula is short. Business value equals normalized earnings times a multiple, plus or minus a few balance sheet items agreed in the deal. Normalized earnings means profit after you strip out expenses the next owner will not have and add the costs they will have. The multiple is the number of years of those earnings a buyer is willing to pay for today, which reflects how risky and how transferable the earnings are. Small owner-operated businesses are usually valued on seller's discretionary earnings (SDE). Larger companies with a management team in place are valued on EBITDA. Revenue multiples exist too, but buyers treat them as a rough sanity check, because two companies with the same revenue can have very different profits.

• Value = SDE x SDE multiple, for owner-operated Main Street businesses
• Value = adjusted EBITDA x EBITDA multiple, for companies with a hired management layer
• Inventory, real estate and working capital are handled separately in many deals

How to calculate seller's discretionary earnings

SDE answers one question: how much cash does this business generate for one full-time owner-operator before that owner pays themselves and before financing decisions. You start from net income on the tax return or the profit and loss statement and add back items that are either the owner's personal benefit, non-cash, related to how the business is financed, or truly one-time. Every add-back has to be documented, because buyers and SBA lenders test them line by line. A recurring expense the owner calls one-time, like an annual equipment repair, is not an add-back.

• Owner's salary and payroll taxes on it, for one owner
• Owner's health insurance, retirement contributions and other personal benefits
• Interest expense, because the buyer will finance the purchase their own way
• Depreciation and amortization, which are accounting entries, not cash spent this year
• Documented one-time costs such as a lawsuit settlement or a relocation
• Personal expenses run through the company, such as a family car or travel

EBITDA and adjusted EBITDA for larger companies

EBITDA stands for earnings before interest, taxes, depreciation and amortization. The key difference from SDE is that EBITDA assumes the owner is paid a market salary for the job they do, or that a hired general manager runs the business. That makes EBITDA the right measure when the buyer is a private equity fund, a search fund or a strategic acquirer who will not personally work in the company. Adjusted EBITDA adds back the same one-time and personal items as SDE, but then subtracts a fair market cost for management. In many deals the line between the two measures sits somewhere around 1 M USD of earnings, though industry and buyer type matter more than a fixed threshold. Using SDE with an EBITDA multiple is one of the most common reasons owners overestimate their price.

A worked business valuation calculation step by step

Take a commercial cleaning company with 1.8 M USD in annual revenue and 180 000 USD of net income on its tax return. The owner draws a salary and runs some personal costs through the business. Here is how a broker would recast it.

With SDE of 400 000 USD and a multiple range of 2.5 to 3.5, the value lands between 1.0 M and 1.4 M USD, with a midpoint of about 1.2 M USD. Cross-checked on EBITDA of 305 000 USD at 3.5 to 4.5 times, the range is about 1.07 M to 1.37 M USD. When both methods point to a similar band, the seller has a defensible asking price. If they diverge widely, one of the inputs (usually the add-backs or the multiple) needs another look. Notice how much the add-backs matter. Of the 400 000 USD of SDE, more than half comes from items that are not on the bottom line of the tax return. That is normal for an owner-operated company, but it is also why every one of those 220 000 USD of adjustments must be documented. If a buyer rejects the 15 000 USD settlement and the 10 000 USD vehicle costs, SDE falls to 375 000 USD and, at a three times multiple, the value drops by 75 000 USD.

You can run the same math for your own numbers in the business valuation calculator, which shows the multiple it applies and a low, mid and high value.

Where valuation multiples come from

Multiples are not set by a rule. They come from what buyers have actually paid for similar companies, and brokers read them from comparable transaction data and their own closed deals. As broad market guidance, many Main Street businesses trade somewhere around 2 to 3.5 times SDE, and lower middle market companies often trade around 4 to 7 times EBITDA, with wide variation by industry and interest rates. Within any range, the specific factors below push a company up or down.

• Size of earnings, since larger earnings attract more and better-financed buyers
• Dependence on the owner for sales, customer relationships or technical skills
• Customer concentration, especially when one account is more than 15 to 20 percent of revenue
• Recurring or contracted revenue versus one-off project work
• Three-year trend, with growth earning a premium and decline a discount
• Industry demand among buyers, with essential services such as HVAC, plumbing and accounting often attracting more bidders
• Condition of equipment, length of the lease and any licensing hurdles
• Quality of the books, because unverifiable earnings get discounted or ignored

Enterprise value, asking price and what you take home

The formula gives an enterprise value, the price for the operating business. Most Main Street sales are structured as asset sales on a cash-free, debt-free basis: the seller keeps the cash in the bank and pays off loans at closing, and the buyer receives the assets free of liens. Inventory is often added at cost on top of the price, counted on the day of closing. Real estate owned by the seller is usually valued and sold separately, or leased to the buyer. The asking price on a listing is commonly set a little above the expected value to leave room to negotiate. What you take home is the price minus debt payoff, broker fees, legal and accounting costs and taxes, and part of the price may arrive later through a seller note or an earnout. Our guide to how to value a small business covers the asset and income methods that sit beside the multiple.

Common mistakes when applying the formula

Most overpriced listings share a few errors. Owners add back expenses that the business really needs, such as the salary of a family member who works full-time. They apply a multiple they heard for a different industry or a much larger company. They use their best year instead of a weighted average of the last three. And they forget that a buyer financing the purchase must be able to service the debt from the same earnings. A buyer using an SBA loan to buy a business typically needs earnings that cover the annual loan payments with a comfortable margin, so a price the cash flow cannot support simply does not get financed, no matter what the multiple suggests.

• Do not add back costs the next owner will still pay
• Weight recent years more heavily, but use all three
• Match the earnings measure to the multiple (SDE with SDE multiples, EBITDA with EBITDA multiples)
• Test the price against loan payments before you list