How to Value a Business Using Multiples of Earnings
Teaching business owners how to value a business is one of the primary goals of this website.
For middle-market businesses (with business values in excess of $5,000,000), we provide a lot of information in regards to how to value a business using EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). For main street businesses (business valued below $5,000,000), we provide the most comprehensive information on the Internet about How Small Businesses Are Valued Based on Seller's Discretionary Earnings (SDE).
To learn how to value a business, you must first understand how to calculate “earnings” as defined by EBITDA, Adjusted EBITDA or Seller’s Discretionary Earnings (SDE). The business value is then derived by applying the appropriate multiple to the “earnings” number. But be careful! The appropriate multiple of earnings depends on the definition of “earnings” being used. Read this article to learn how SDE vs. EBITDA vs. Adjusted EBITDA Leads to Multiples Confusion.
How to Value a Business in Excess of $5,000,000 Using EBITDA Multiples
- The value of a business is usually based on EBITDA multiples for larger businesses.
- In some instances, the business value is dependent on EBITDA multiples by industry.
- EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization.
- EBITDA calculations are therefore Earnings + Interest + Taxes + Depreciation + Amortization.
- Adjusted EBITDA also adds back an owner’s entire salary then imputes replacement wages for a person hired to run the company. Adjusted EBITDA is used to value a business when its owner is paid more than fair market value.
For a business that values less than $5,000,000, you need to understand how to value a business using earnings multiples Of SDE:
How to Value a Business less than $5,000,000 Using SDE Multiples
- Small business valuation is usually calculated on multiples of earnings based on Seller’s Discretionary Earnings (SDE).
- In calculating SDE, the value of all owner's compensation, including perks, is added to EBITDA.
- Therefore, Seller’s Discretionary Earnings (SDE) equals EBITDA + owners compensation + other owner benefits.
- Because SDE results in a higher base number than EBITDA, the EBITDA earnings multiple is a higher number than the SDE earnings multiple.
- Similar to large business valuations, the business value may be dependent on EBITDA multiples by industry. However, when viewing the EBITDA multiples chart, keep in mind that by definition SDE multiples are less than SDE multiples.
- We have a very specific example of calculating EBITDA, Adjusted EBITDA and SDE in this newsletter: An Example of SDE vs. EBITDA vs. Adjusted EBITDA.
How to Value a Business Using Multiples of Earnings - Newsletter Articles
This website provides six sequential newsletters with very detailed and specific information about how to value a business including: earnings multiple valuation and examples of calculations of EBITDA, Adjusted EBITDA and Seller’s Discretionary Earnings (SDE). To determine how to value a business, read these six newsletters:
The following newsletter articles also address important aspects of business valuations:
Other Resources for Information About How to Value a Business
In addition to the above six articles, here’s a list of other articles addressing specific aspects of business valuation:
- EBITDA Multiples by Industry – contains a chart of the appropriate EBITDA multiples for eleven categories of industry types. As EBITDA increases the multiples increase, so the chart has 3 columns for EBITDA levels below $1,000,000, EBITDA between $2,000,000 and $5,000,000 and EBITDA between $5,000,000 and $10,000,000.
- EBITDA Example – The “T” in EBITDA is for “Taxes”, which are income taxes. If you are using the company tax returns to develop EBITDA, the bottom line on the tax return is already income before taxes, so there’s no add-back for taxes (except you may be able to add back state income taxes which are deducted on the federal tax return. You can add back income taxes into computing EBITDA if the source of the information is the financial statements and the net income is after income taxes. The article provides an example of the calculation of EBITDA.
- Adjusted EBITDA Calculation – provides an example of adjusting EBITDA for excess compensation paid to the business owner and excess lease payments to the business owner’s personal entity which owns the facility the business is housed in. The bottom line is compensation and rent need to be normalized at fair market value.
- Add Backs for Business Valuation – provides example so other types of add backs that should be considered when normalizing earnings to calculate Seller’s Discretionary Earnings. The article also addresses the fact that sellers, buyers and lenders may not agree on the validity of certain add backs.
- Earnings Multiples for Small Business – provides more information on EBITDA, Adjusted EBITDA, and Seller’s Discretionary Earnings (SDE) and provides an example.
- How to Valuate a Company – discusses alternate methods of valuation other than multiples of earnings. Rules of thumbs are discusses but should be avoided. Unprofitable businesses or marginally profitable businesses may have to be valued solely on the fair market value of their assets. The article also provides a brief explanation of professional business valuations.
- How to Value a Small Business For Sale – provides a basic explanation of how to value a small business.
- What Is My Company Worth? – provides an overview of why it’s important to ask that question with a brief explanation of the methods to value a business.
- How Much Is a Business Worth? For Sellers, Buyer and Investors – provides insights for sellers, buyers and investors on the importance of understanding how to value a business.
- How Do I Value a Business? – suggests that many business brokers will provide a no charge, no obligation evaluation of a business, including a broker’s opinion of value. However, be sure to find a qualified business broker. Read our Special Report “Insider Secrets to Selling Your Business - Business Broker Best Practices and Selection Criteria”.
- How to Value Goodwill When Selling a Business - explains how goodwill is calculated and provides an example.
Note #1: There are multiple business valuation methods. Valuing a business can depend on many factors. Multiples of earnings is only one method used by professional business valuation firms. But using earnings multiples is the most common method used by business brokers.
Note #2: Other than the simplified calculations of EBITDA shown above, there are many other types of adjustments required to normalize or recast financial statements before an earnings multiple is applied. It is important to read the details and examples of EBITDA adjustments in the newsletters to gain a better understanding.