How Small Businesses Are Valued, and What an SBA Lender Will Accept

A small business is almost never priced from its assets. It is priced from what it earns, multiplied by a number that reflects how reliable those earnings are. Understanding both halves of that sum is most of what a buyer needs to judge an asking price.

Earnings: SDE or EBITDA

Smaller, owner-run businesses are usually priced on seller's discretionary earnings (SDE): profit with the owner's salary, benefits and personal expenses added back, plus interest, depreciation and one-time costs. It answers the question: what does this business pay one full-time owner?

Larger businesses with a management team are usually priced on EBITDA instead: earnings before interest, taxes, depreciation and amortization, after paying a market salary for every role, including the one the owner fills today.

The difference matters. The same business can show a much larger SDE than EBITDA, and a multiple quoted for one should never be applied to the other.

Add-backs decide the price

Every dollar added back to profit is multiplied into the price. That is why add-backs are where most valuation disagreements happen.

A legitimate add-back is documented and will not continue under a new owner: the seller's personal vehicle, a one-time legal bill, a family member on payroll who does not work in the business. A doubtful one is an expense the business actually needs, relabelled as discretionary. Ask for a schedule that lists each add-back with the document behind it, and reconcile the adjusted figure back to the tax returns yourself.

Lenders do the same exercise, and they underwrite from the tax returns. If the add-backs do not hold up, the lender's number will be lower than the listing's.

The multiple: why two similar businesses sell for different prices

The multiple is a judgment about risk and transferability. It tends to be higher when revenue is recurring, customers are spread out, staff run the day to day, the business has grown steadily, and the industry has plenty of buyers. It tends to be lower when the owner holds the key relationships, a few customers make up much of the revenue, or the earnings jumped in the year before the sale.

There is no single correct multiple for an industry. Treat published ranges as a starting point and price the specific business in front of you.

The SBA's valuation rules

For a 7(a) business acquisition, the lender has to get an independent business valuation from a qualified, accredited source, prepared for the lender rather than for the buyer or the seller. The exception is a business purchase price of $350,000 or less where the buyer and seller do not have a close relationship: there, the lender may do its own internal valuation. The detail is on our business valuation rule page.

When the business purchase price is $3 million or more, a quality of earnings report is also required for a first acquisition (the quality of earnings rule).

If the agreed price comes in above the value those reports support, the SBA loan does not simply cover the difference. The rules allow additional seller debt on full standby to bridge it, otherwise the buyer renegotiates or brings more cash.

Price versus what can be financed

A valuation tells you what the business is worth. The payment tells you what it can afford to carry. Before you agree a price, check that the business's cash flow, after paying you a reasonable salary, covers the loan payments with room to spare: lenders commonly look for 1.25 times coverage. Our loan size examples show the annual payments at common amounts.

If the cash flow does not cover the price, a lower price or a larger down payment is the answer, and it is far easier to get to that before the letter of intent than after the valuation comes back short.