OnwardLesson 3.2
Where the number comes from: earnings, not revenue
Buyers pay for the money a business earns for its owner, not the money it brings in.
The short version
- Buyers pay for the money a business earns for its owner, not the money it brings in.
- Two businesses with the same revenue can be worth very different amounts.
- Most small businesses are valued as SDE or EBITDA multiplied by a number, called a multiple. SDE is usual for businesses earning under about $1 million, and EBITDA above that. Brokers and lenders differ, so always ask which measure a number uses.
- The multiple reflects risk. The safer and steadier the earnings, the higher it goes.
Why earnings, not revenue
Revenue is everything customers pay you. Earnings are what is left for the owner after the business pays its costs.
A buyer cares about earnings for a simple reason. Earnings pay the buyer's salary, and they pay back the loan most buyers use to buy the business. Revenue that does not turn into earnings does neither.
Two companies in the same trade can each bring in $1.2 million a year. One keeps $300,000 for its owner. The other keeps $100,000. The first is worth far more, even though the revenue is identical.
How the number is built
Most small businesses are valued with a simple formula:
SDE or EBITDA × multiple = value
Buyers measure earnings in one of two ways:
- SDE, seller's discretionary earnings. What the business produces for one full-time owner, including the owner's own pay. It is the usual measure for businesses earning under about $1 million, where the buyer will often run the business themselves.
- EBITDA, earnings before interest, taxes, depreciation and amortization. What the business earns after paying someone a fair salary to run it. It becomes the more common measure once EBITDA passes about $1 million and buyers expect a paid manager.
Practice varies. Brokers, lenders and buyers each have their own habits, and the same business can be described both ways.
Both figures are adjusted to show what the business really makes. Personal expenses run through the business and one-time costs are added back. Lesson 5.3 covers these add-backs. Lesson 3.3 explains the two measures in full and which one fits your business.
The multiple is the number of years of SDE or EBITDA a buyer is willing to pay for. It is lower when the earnings look risky and higher when they look safe and steady. Size, customers, how much the business depends on you and the state of your books all move it. Step 4, Know what buyers value most, covers each one.
Where revenue still matters
Revenue is not ignored. Buyers look at whether it is growing, flat or falling. They look at how it is spread across customers. They look at whether it repeats. Those answers shape the multiple.
Always match the measure to the multiple
A multiple of SDE and a multiple of EBITDA are not the same thing. SDE is the larger number, so SDE multiples are lower. When anyone quotes you a multiple, ask which measure it applies to. Lesson 3.3 shows why this matters.
When you are ready to talk to someone
Nobody needs to know you read this. When you are ready, these are the questions to bring.
- For your accountant: "What are my SDE and my EBITDA, once personal and one-time expenses are added back?" Listen for: a specific SDE or EBITDA figure, with each adjustment listed and explained.
- For your accountant: "Which of those adjustments would a buyer's lender accept, and which would they question?" Listen for: an honest split. Adjustments without records behind them are usually the first to be challenged.
Measures from conventions commonly used by business brokers and lenders; practice varies. Benchmarks describe what happened in other sales. They do not predict yours.
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