How to value a small business before you talk to a buyer

My broker says it's worth 5 times earnings, so that's the value

A broker's figure is an estimate made to win a listing, not a guaranteed valuation. Buyers price an acquisition on their own adjusted earnings after conducting rigorous diligence, meaning the initial broker estimate serves merely as a starting bid. Four core valuation methods regularly surface in negotiations. A multiple of seller's discretionary earnings (SDE) adds back the owner's full compensation and primarily applies to owner-operated companies with under $1,000,000 of profit. A multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA) takes over once a salaried leadership team can replace the owner. Sophisticated corporate buyers rely on discounted cash flow to project future expansion, while an asset-based method fits capital-intensive or marginally profitable operations.

Consider Kavya, a hypothetical person aged 46, who operates a medical billing company. An SDE of $1,000,000 (representing EBITDA of $800,000 plus her $200,000 salary) at a 4 times multiple yields $4,000,000. An EBITDA of $800,000 at a 5 times multiple also equals $4,000,000. The underlying calculation method dictates the multiple, which is why an owner must confirm exactly which earnings baseline is being evaluated before agreeing to pricing.

A practical decision threshold applies here: if a single customer generates more than 20% of your total revenue, or if you cannot step away from operations for 30 consecutive days without billing volume dropping, expect buyers to push for a discounted multiple or defer more consideration into future milestones. Kavya's proposed 30% earn-out is precisely the structural discount that concentrated operational dependence creates.

Any 2 appraisals will land in the same place

Different valuation engagements follow distinct standards and serve entirely different masters. A broker's opinion of value costs little or nothing because its exclusive role is pricing a commercial listing, and the IRS will flatly reject it on an estate tax or gift filing. In contrast, a qualified appraisal performed by an accredited appraiser carrying credentials such as ASA, ABV, or CVA requires an engagement fee paid by the business owner. This formal report establishes fair market value specifically for family gifts, buy-sell agreements, marital dissolutions, or transfer taxes.

A quality of earnings (QoE) report introduces a third perspective, typically commissioned by a buyer's audit team during transaction diligence to scrutinize EBITDA month by month. That audit is where unsupported owner adjustments get stripped away. Commissioning an independent sell-side QoE before signing a letter of intent exposes those accounting vulnerabilities early. For an outright sale, a thorough sell-side QoE protects pricing far more effectively than an appraisal, whereas lifetime transfers of company stock require a qualified formal appraisal.

My $40,000 of add-backs will speak for themselves

Acquirers accept an earnings add-back only when verifiable third-party records prove the expense will not recur under new ownership. A simple notation on an internal spreadsheet carries no weight, and any adjustment lacking evidence gets removed directly from earnings at the multiple. Decision rule: if an add-back can't be tied to an invoice, a lease, a payroll record or a board minute, leave it out of your own estimate of value. At a 5 times multiple, each unproven $10,000 is $50,000 of price you shouldn't count on.

To see how this works, return to Kavya, a hypothetical person who sole-owns her medical billing C corporation. Her baseline $800,000 EBITDA includes $40,000 of claimed adjustments: a $15,000 corporate lease on her personal vehicle and a $25,000 one-time software migration cost. Without paperwork, the buyer strikes the entire $40,000 during diligence, reducing EBITDA to $760,000. At a 5 times multiple, the headline acquisition price falls from $4,000,000 to $3,800,000, representing a $200,000 loss in enterprise value. With documented equipment agreements and vendor contracts retained in advance, the $4,000,000 valuation stands firm.

Seen tax-first, that preserved $200,000 is taxable capital gain. Using an assumed 24% blended federal rate for illustration on a stock sale without special exclusions, keeping the paperwork leaves Kavya $152,000 after tax. If her corporate shares meet the requirements of Section 1202, that portion could be excluded from federal capital gains tax, though nobody has confirmed she qualifies yet. With 30% of the price structured as an earn-out, $140,000 of the retained value pays out at closing and $60,000 depends on operating benchmarks over the next 3 years. We cover installment sale of a business: spreading the tax cost over years in a separate analysis.

The $4,000,000 in the letter of intent is what I'll keep

The headline price is the top line of a settlement waterfall. It is not the money Kavya takes home. What actually reaches her at closing is the price minus deferred consideration she hasn't earned yet, corporate debt payoffs, working capital true-ups and advisory fees, and income tax comes off after that. Her numbers look like this: $4,000,000 less the $1,200,000 three-year earn-out is $2,800,000. Take away $200,000 of transaction costs and a $100,000 working capital peg adjustment, and she wires $2,500,000 of pre-tax cash to her account at settlement.

Entity structure moves the tax bill more than haggling over the multiple does. When a C corporation sells its assets, the company pays tax on the gain, and the owner pays again when the proceeds are distributed. A stock sale skips that second layer and may qualify for the federal Section 1202 exclusion if the shares meet its requirements. Our companion guide on asset sale vs. stock sale: what each costs the seller in tax works through both cases. When Corient Wealth Management invests the proceeds after a sale, we tell owners plainly that every portfolio carries market risk, including loss of principal, and that past performance does not guarantee future returns.

When does the calendar lock in the value of a small business?

Buyers value a business by multiplying the trailing 12 months of audited earnings and cross-checking those figures against the company's past 3 years of filed corporate income tax returns. For a calendar-year operating corporation, the official Form 1120 filed with the IRS sets the documented baseline against which every requested add-back must be reconciled.

Transaction values hinge on a calendar of operational and accounting deadlines that owners often overlook. One operational assumption behind the table figures is a steady 5 times multiple on audited adjusted earnings throughout the fiscal cycle. Notice that 3 of the 5 dates in the schedule represent administrative documentation deadlines rather than tax payments, and the mid-year accounting close resets the trailing 12-month earnings calculation that acquirers use to determine their formal offer price.

What happens if the family hears a bigger number than you'll keep?

In most business-owning households, a spouse asks first about what the family will actually keep once rumors of a transaction circulate. For a divorced single parent like Kavya, the question comes from the calendar instead, because her child starts college in about 2 to 3 years, inside the 3-year earn-out window.

Tuition should be planned from the $2,500,000 in cash at closing and not from earn-out dollars, and she should reread her divorce decree for any claim tied to the company or its sale proceeds.

3 valuation errors careful owners make, with the CPA questions that catch them

Paying an above-market year-end bonus to keep C corporation profit low is careful tax planning that costs price when it isn't documented. For an owner selling at 5 times earnings, a $30,000 excess bonus the buyer won't add back takes $150,000 off the offer, about $114,000 after an assumed 24% federal rate. Maintaining board minutes, payroll records, and market-salary surveys preserves that adjustment. Second, building personal lifestyle or college calculations on the headline $4,000,000 offer rather than the $2,500,000 net pre-tax closing cash overstates spendable liquidity by $1,500,000. Third, attempting to repurpose an M&A broker valuation to report family share transfers creates audit exposures with the IRS, requiring a second qualified appraisal that disrupts family gifting schedules.

Take these specific questions to your advisory meetings before signing an initial letter of intent:

• which add-backs tie to paperwork
• do my shares meet Section 1202
• which earnings, which 12 months, which multiple
• is this fit for a gift return
• does the plan end at closing
• after-tax cash with and without 1202

Before an offer, Corient Wealth Management reads 3 years of returns

The first thing we look at is the last 3 Forms 1120 next to the add-back list, marking which items have paperwork. Then Corient Wealth Management reviews the owner's personal accounts to see how much of household net worth rests on cash at closing and how much on conditional earn-out payments. Last, our advisors calculate net proceeds under several deal allocations, with and without Section 1202 qualification, so the owner sees the after-tax figure for each structure before answering a buyer.