Valuation fine print: multiples, SDE vs EBITDA, and listing vs selling price

What is a small business valuation multiple?

A valuation multiple is the number a buyer multiplies a measure of profit by to arrive at a price. If a business earns 400,000 dollars a year in owner's benefit and sells for 1.2 million, it sold at a multiple of 3.

Multiples are shorthand for risk and growth. A higher multiple means the buyer is paying more for each dollar of profit, usually because they believe that profit is reliable, transferable and likely to grow. A lower multiple means they see more risk. The multiple is only meaningful when you know which profit figure it applies to, which is where SDE and EBITDA come in.

What is SDE, or seller's discretionary earnings?

Seller's discretionary earnings (SDE), sometimes called owner's benefit or owner's cash flow, is the total financial benefit one full-time owner gets from the business in a year. It is the most common profit measure for smaller, owner-operated businesses.

To calculate SDE, start with pre-tax profit, then add back:

• The owner's salary and benefits (for one owner).
• Interest, depreciation and amortisation.
• Personal expenses run through the business.
• One-off costs that will not recur, such as a lawsuit or a major repair.

The result shows a buyer what they would have available to pay themselves, repay any loan and reinvest, if they ran the business the way you do.

What is EBITDA and when is it used instead?

EBITDA is earnings before interest, taxes, depreciation and amortisation, after paying a market-rate salary for the people who run the business. It is typically used for larger businesses where the owner is not the main operator.

The key difference is the owner's pay. SDE adds the owner's full compensation back. EBITDA assumes the buyer will need to pay a manager, so it deducts a fair salary for that role. For the same business, EBITDA is therefore lower than SDE, and EBITDA multiples tend to be higher. Comparing an SDE multiple with an EBITDA multiple is comparing two different things, which is a common source of confusion.

As a rough guide, many small, owner-run businesses are discussed in SDE terms, while businesses with a management team and earnings above roughly a million dollars are more often discussed in EBITDA terms. There is no fixed cut-off.

Are high multiples always good?

A high multiple is good news only if the profit figure underneath it is real and the terms are sound. A high multiple on inflated or unverifiable earnings tends to fall apart in due diligence.

Owners sometimes hear about a neighbour's business selling for a high multiple and expect the same. But multiples reflect the specific business: its size, growth, customer concentration, owner dependence and industry. A multiple can also look high because the deal includes seller financing or an earnout, where part of the price depends on future results. Always ask what profit measure was used and how much of the price was paid in cash at closing.

What are typical multiples by business size?

Multiples generally rise with size because larger businesses tend to carry less risk. The figures below are broad, hedged ranges, not rules, and individual industries can sit well outside them.

• Very small businesses (SDE under roughly 250,000 dollars): often around 1.5 to 3 times SDE.
• Small businesses (SDE of roughly 250,000 dollars to 1 million): often around 2.5 to 4 times SDE.
• Lower middle market businesses (EBITDA of roughly 1 to 5 million dollars): often around 4 to 7 times EBITDA.
• Larger businesses: often higher again, especially with strong growth or strategic appeal.

Treat these as conversation starters. A professional valuation using recent comparable sales in your industry is the only reliable way to place your business within or outside these ranges.

What is the difference between listing price and selling price?

The listing price is what the business is offered at. The selling price is what a buyer actually pays at closing. The gap between them depends on how well the asking price was supported in the first place.

A listing price set from a careful valuation gives room to negotiate while still landing close to it. A price set from hope, or from a broker promising a high number to win the listing, often leads to a business sitting on the market, buyers losing interest and a lower final price. Long time on market can itself become a negotiating point against you.

The selling price is also not the same as what you take home. Fees, taxes, debt payoff, working capital adjustments and any amount paid later through seller financing or an earnout all sit between the headline figure and the money in your account.

How do buyers check the profit figure behind the multiple?

Buyers check the profit figure by matching it to tax returns, bank statements and financial statements, and by asking for evidence behind every add-back. Add-backs that are well documented usually survive; vague ones are often removed, which lowers the price even if the multiple stays the same.

How should I read a valuation multiple I hear about?

Ask four questions whenever someone quotes a multiple: multiple of what (SDE, EBITDA or revenue), for what size of business, in what industry, and on what terms. Without those answers, a multiple is just a number. With them, it becomes a useful benchmark for your own sale.