Business valuation methods explained: the three ways buyers price a business

This guide is for owners who want to know what their business is worth. It also helps first-time buyers who want to check a price. By the end you will know the three business valuation methods, which one buyers will use on your company, and how to run a rough number yourself.

What are the main business valuation methods?

Every valuation uses one of three methods, or a mix of them. Appraisers call them approaches. Each one asks a different question.

The IRS set out the classic list of things to weigh in Revenue Ruling 59-60. It still guides tax and court valuations. The ruling defines fair market value as the price a willing buyer and a willing seller would agree on. Neither one is forced to act, and both know the relevant facts.

The ruling lists eight factors. They include the company's history, the outlook for its industry, its book value, its earning power, its goodwill and the prices paid for similar companies. Each method gives more weight to some of these factors.

How does the market method work?

The market method takes one earnings number and multiplies it by a multiple. The multiple comes from sales of similar businesses. The formula is simple:

Value = earnings × multiple

The hard part is picking the right earnings number and the right multiple.

For small, owner-run businesses, the earnings number is usually seller's discretionary earnings (SDE). That is profit plus the owner's salary, perks and one-off costs. For larger businesses with a manager in place, it is EBITDA. That leaves a market salary for the manager in the costs.

The IBBA and M&A Source Market Pulse survey uses the same split. In its Q4 2025 highlights, deals up to $2M are shown as a multiple of SDE. Deals from $2M to $50M are shown as a multiple of EBITDA. The larger size bands carry higher multiples.

Brokers also use "rules of thumb", such as a share of yearly revenue for a given industry. They are a quick sanity check, not a valuation. Two firms with the same revenue can have very different profits.

How does the income method work?

The income method asks what the future cash is worth in today's money. There are two versions.

Capitalization of earnings. You take one year of normal cash flow and divide it by a capitalization rate. The rate reflects risk. A riskier business gets a higher rate, which means a lower value. This version fits a business that grows slowly and steadily.

Discounted cash flow (DCF). You forecast cash flow for five or so years. Then you discount each year back to today and add a value for the years after. DCF fits a business that is growing or changing fast. It is only as good as the forecast. A small change in the growth or discount rate can move the value a lot.

Buyers who use SBA loans run a simpler income test: can the cash flow pay the loan? Lenders want cash flow to cover the yearly loan payments with room to spare. If the price fails that test, the price usually comes down.

How does the asset method work?

The asset method adds up what the business owns and subtracts what it owes. Owned items include equipment, vehicles, inventory, property and cash. Debts include loans, payables and other liabilities.

There are two common versions:

• Adjusted book value. Each asset is restated from its book value to its fair market value today.
• Liquidation value. What the assets would fetch if the business closed and sold them, often quickly.

For a profitable service business, the asset value is usually well below the market value. The gap is goodwill: customers, staff, brand and systems. Our glossary entry on goodwill explains how it is booked after a sale. The asset value still matters. It acts as a floor, and lenders look at it as collateral.

Which business valuation method fits your business?

Size and type of business decide which method leads. Here is how it usually works out.

In over ten years of advising buyers and sellers, I have seen most deals in our range priced on the market method. Most of those businesses have $500K to $50M in revenue. Buyers then test that price with debt service and diligence. The other methods are mostly there to check the first one.

A worked example: one business, three methods

Here is a made-up home services business. The numbers are only there to show the math. They are not market data.

• Revenue: $2,500,000
• SDE: $400,000
• A general manager would cost $120,000 a year, so EBITDA is $280,000
• Yearly spending to replace trucks and tools: $30,000
• Equipment, vehicles and inventory at fair value, less debts: $350,000

The market and income results land close together. That is a good sign the price range is sensible. The asset result is much lower, so most of the value here is goodwill. A buyer paying $1,200,000 is paying about $850,000 for the customers, crew and reputation. The buyer will want proof those will stay after the sale.

What moves the multiple up or down?

Two businesses with the same earnings can sell for very different prices. These factors move the multiple:

1. Owner dependence. If the owner sells, prices and fixes everything, buyers pay less. A manager who already runs the day raises the price.
2. Recurring revenue. Service contracts and repeat customers are worth more than one-off projects.
3. Customer concentration. One customer with a large share of sales is a risk. See customer concentration.
4. Clean books. Tax returns, P&L and bank statements that agree make buyers trust the earnings. Weak add-backs get thrown out.
5. Trend. Three steady or rising years beat one great year.
6. Size. Larger businesses attract more buyers, including private equity, and higher multiples.
7. Sector demand. Some sectors have many active buyers. Our HVAC valuation multiples post shows how this plays out in one sector.

The market moves too. In its Q4 2025 survey press release, the IBBA reported that 71% of surveyed advisors expected multiples to hold steady.

When do you need a formal valuation?

A rough valuation is fine for planning. A formal one, from a credentialed appraiser or CPA, is needed in some cases:

• SBA-financed sales. The SBA's lender rulebook, SOP 50 10, sets when a lender must get a business valuation for a change of ownership. Version 8.1 took effect on October 1, 2026. Ask the buyer's lender which rule applies to your deal.
• Gifts, estates and trusts. The IRS expects a fair market value backed by a proper appraisal.
• Partner buyouts, divorces and disputes. Courts and lawyers want an independent number.
• Employee ownership plans. These need a yearly independent valuation.

Tax and legal questions change with every deal. Talk to a CPA and a lawyer before you rely on a valuation for a tax filing or a court case.

How should a seller use valuation before going to market?

A valuation is a starting point for talks, not a promise. The final price is what a real buyer pays, on terms a lender will fund. Use these steps:

1. Rebuild three years of SDE or EBITDA with every add-back documented.
2. Run the market method with a range of multiples, not one number.
3. Check the result against debt service. Can a buyer with a normal SBA loan pay for it from the cash flow?
4. Find the weak points that cut the multiple, such as owner dependence or concentration. Fix what you can before you list.
5. Decide which terms matter to you. A seller note or an earn-out can raise the headline price, and each one carries risk.

If you want a second opinion on your number, our sell-side team can walk through it with you. You can also book a free first call.

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