How to Value a Small Business: What Buyers and Lenders Actually Look At

Guys, let me start with something that trips up almost every first-time buyer I work with: the value of a business is not what the seller says it's worth. It's not what a multiple calculator on the internet says it's worth. And it's definitely not what the buyer hopes it's worth.

The value of a business is what a qualified buyer can pay, a lender can support, and both parties can agree on — all at the same time. Those three numbers are almost never identical, and understanding the gap between them is what separates buyers who close deals from buyers who chase them for months and walk away frustrated.

I've been on the lending side of business valuations for over 25 years. I've seen businesses sell for twice what they were worth and businesses sell for half. In both cases, somebody made a mistake. Here's how to avoid being that somebody.

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Seller's Discretionary Earnings (SDE)

For businesses under about $5 million in revenue — which is the majority of acquisitions financed through the SBA (Small Business Administration — the federal agency that guarantees small business loans) — SDE is the standard valuation metric. Not EBITDA, not revenue multiples, not asset value. SDE.

So what is SDE (Seller's Discretionary Earnings — the total cash a business generates for its owner after all expenses)? It's the total financial benefit the business provides to a single owner-operator. Here's how you calculate it:

Net Income (from the tax return, not the internal P&L — the Profit and Loss statement showing revenue, expenses, and net income) + Owner's salary and benefits + Personal expenses run through the business (car, phone, meals, travel, insurance) + Depreciation and amortization + Interest expense on business debt + One-time or non-recurring expenses (lawsuit settlement, equipment purchase, relocation costs) = Seller's Discretionary Earnings

The critical word in that formula is "discretionary." SDE represents the cash flow available to a new owner who replaces the current owner. It assumes one owner, working full-time in the business.

Here's the thing. The SDE calculation is only as good as the documentation behind it. Every add-back — personal expenses the current owner ran through the business that a new owner wouldn't have — needs to be verifiable.

If the owner claims $50,000 in personal car expenses run through the business, I want to see the auto expense line item on the tax return. If the owner claims a $30,000 one-time expense for equipment that won't recur, I need to understand why it won't recur and whether similar expenses might show up in the future. The financial due diligence process is where every one of these add-backs gets tested.

SDE Multiples by Industry

Once you have a defensible SDE number, you apply a multiple. The multiple reflects the risk, growth potential, and desirability of the business. Here are the ranges I see most commonly in SBA-financed deals:

• Service businesses (low barrier to entry): 1.5x to 2.5x SDE — cleaning companies, landscaping, general contracting, consulting
• Professional practices: 2.0x to 3.5x SDE — dental, veterinary, accounting, medical practices
• Established retail/restaurant: 2.0x to 3.0x SDE — location-dependent, lease terms matter heavily
• Manufacturing: 2.5x to 4.0x SDE — equipment value, customer contracts, and barriers to entry push multiples higher
• Franchise businesses: 2.5x to 4.0x SDE — brand recognition, systems, and territory rights add value
• Technology/SaaS (Software as a Service — subscription-based software, small scale): 3.0x to 5.0x SDE — recurring revenue models command premiums

These are ranges, not rules. A landscaping company with $500,000 in SDE, 15-year customer relationships, three crews, and systemized operations is a very different business than a landscaping company with $500,000 in SDE where the owner does half the work personally. Same SDE, different multiples.

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EBITDA: When and Why It's Used Instead

For larger businesses — generally those with revenue above $5 million or SDE above $1 million — the valuation metric shifts from SDE to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization — a measure of business profitability before accounting adjustments).

The difference between SDE and EBITDA is essentially the owner's compensation. SDE adds back the owner's salary because it assumes a single owner-operator. EBITDA does not add back the owner's salary because it assumes the business has professional management and the owner's role would be filled by a paid manager.

EBITDA multiples run higher than SDE multiples because they're applied to a smaller number. Typical EBITDA multiples for SBA-range businesses:

• Main street businesses: 3.0x to 4.5x EBITDA
• Lower middle market: 4.0x to 6.0x EBITDA
• Businesses with recurring revenue or strong moats: 5.0x to 7.0x EBITDA

All right, here's what I tell buyers: don't get caught up in whether to use SDE or EBITDA. Use whichever metric the lender and the market use for that type and size of business. What matters is that the calculation is accurate and the multiple is defensible. An inflated SDE with a reasonable multiple and a legitimate SDE with an inflated multiple both produce the same bad outcome — you overpay.

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Asset-Based Valuation

Some businesses are worth more dead than alive. I don't mean that to be harsh, but it's true. When the earning power of the business is low relative to the value of its tangible assets, an asset-based valuation becomes the relevant metric.

This approach values the business based on the fair market value of its tangible assets — equipment, real estate, vehicles, inventory — minus liabilities. It's most commonly used for:

• Manufacturing businesses with significant equipment
• Businesses that include commercial real estate
• Asset-heavy operations like trucking, construction, or agriculture
• Businesses with declining earnings but valuable physical assets

Lenders care about asset value even in earnings-based valuations because assets represent collateral — assets the lender can seize if the loan isn't repaid. If the SBA loan goes into default, the lender needs to recover what they can from the assets. A business with strong earnings and minimal assets is a different credit profile than a business with strong earnings backed by $500,000 in equipment.

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Market Comparisons

How do you know if a multiple is reasonable? You look at what similar businesses have actually sold for. This is the market comparison approach, and it's both the most intuitive and the most difficult valuation method in practice.

The challenge is finding true comparables. A dry cleaning business in suburban Dallas is not the same as a dry cleaning business in rural Oregon, even if the revenue is similar. Location, market dynamics, competition, lease terms, equipment condition, customer demographics — all of these factors affect what a business sells for.

Sources for comparable sales data include:

• BizBuySell and similar listing platforms — they publish completed transaction data
• Business brokers — experienced brokers have proprietary databases of closed deals
• Industry associations — some industries publish benchmarking and transaction data
• Appraisers — certified business appraisers maintain databases of comparable sales

I use comps as a sanity check, not as the primary valuation driver. If comparable businesses in the same industry and size range are selling for 2.5x to 3.0x SDE, and the seller wants 4.5x, you have a gap that needs to be justified by something specific and verifiable — not just the seller's opinion that their business is "different."

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What Lenders Care About vs. What Buyers Care About

This is where I see the most friction in deals, and I think it's worth spelling out clearly because misunderstanding this dynamic is what causes deals to stall.

Buyers care about growth potential. The buyer sees a business doing $800,000 in SDE and imagines growing it to $1.2 million through better marketing, new product lines, operational improvements. The buyer is willing to pay a premium because they believe in the upside.

Lenders don't care about your growth plans. Let's get real. The lender is underwriting — reviewing your deal to decide if they'll approve the loan — based on what the business does today, not what you plan to do with it tomorrow.

The DSCR (Debt Service Coverage Ratio — essentially, how much cash the business makes compared to its loan payments) is calculated using historical cash flow, not projected cash flow. If the business generates $300,000 in cash flow available for debt service and the annual debt payment is $250,000, that's a 1.2x DSCR. In plain English: for every $1 of loan payments, the business earns $1.20. Most lenders want 1.15x to 1.25x minimum.

Here's the math that kills deals:

• Buyer agrees to pay $1.2 million
• SBA loan at $1.08 million over 10 years at 10.5% = roughly $175,000/year in debt service
• Business SDE is $250,000, minus a $80,000 owner's salary = $170,000 left for debt service
• DSCR: 0.97x — the business cannot cover the loan payments
• The deal is dead at that price

The seller says the business is worth $1.2 million based on a 3x multiple of $400,000 in "adjusted" SDE. The lender says the supportable SDE is $250,000, the maximum supportable price is closer to $750,000 to $800,000, and the gap between what the seller wants and what the lender will support is $400,000.

That gap doesn't close with enthusiasm or optimism. It closes with negotiation, seller financing, or walking away.

Understanding the full valuation picture from both sides — buyer and lender — is what makes deals closeable.

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Appraisals and Bridging the Gap

For larger SBA loans, most lenders require a third-party business appraisal — the specific threshold varies by lender and deal structure. The appraiser uses all three approaches — income, asset-based, and market comparison — and arrives at a value opinion that becomes a critical input in the lender's credit decision.

Here's what I want buyers to understand: if the appraisal comes in below the agreed purchase price, the lender will not finance the gap. I've seen appraisals come in 20% to 30% below the agreed price. You'll need to renegotiate, increase your equity injection (your cash investment into the deal), or arrange additional seller financing.

Every deal has a valuation gap. Bridging it requires one of three tools:

• Seller financing — the seller carries a standby note (no payments required for a set period), reducing the SBA loan and improving DSCR
• Earnout provisions — a portion of the price contingent on post-sale performance
• Negotiation — the price comes down to match reality

Valuation is where the art and science of business acquisitions meet. Get the science right — SDE calculation, multiple selection, cash flow analysis — and the art becomes much easier.

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Free Valuation Resources

• CalcXML Business Valuation Calculator — Free online tool using a discounted cash flow approach. Good for a preliminary estimate before investing in a professional appraisal
• BizBuySell Insight Reports — Publishes quarterly data on actual business sale prices by industry, useful for market comparison research
• SBA: Buy an Existing Business — Official SBA guidance covering valuation methods including capitalized earnings and cash flow analysis

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This content is for educational purposes only and does not constitute legal, financial, or investment advice. We strongly recommend consulting with a qualified attorney, CPA, and financial advisor before making any business acquisition decisions.

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