Business Valuation Approaches: Understanding The Most Common
Jamie Roth
March 20, 2023 ⋅ 13 min read
This article was originally written in March 2023 and has since been updated with refreshed guidance and research in December 2025.
Most owners don't struggle with the idea that their business has value. They struggle with the fact that the value seems to change depending on who is holding the calculator.
One broker gives a range that feels aspirational. An online tool spits out a number that feels suspiciously simple. A friend swears they “know a buyer who pays 5x,” but cannot explain 5x of what. The surest path out of that noise is understanding the core business valuation approaches, when each one applies, and how buyers actually read the underlying numbers.
The Income Approach: Pricing The Cash Your Business Can Produce
The income approach works when the value of the business is best explained by the cash it can produce, and the risk that cash does not show up as expected. It is the most direct answer to “What is the buyer really buying,” especially in smaller deals where owner effort and reinvestment needs can meaningfully change cash flow.
This section breaks down the three income methods owners hear most often, and what has to be true for each to be credible.
Capitalization Of Earnings (When Cash Flow Is Steady)
Capitalization of earnings is the workhorse when performance is steady enough that the near future looks like a continuation of the recent past. The math is simple. Normalize earnings, then apply a capitalization rate that reflects risk and expected growth.
The hard part is not the formula. The hard part is getting to normalized earnings without wishful thinking, especially in owner-operated businesses where the books can mix business reality with personal reality.
That usually starts by normalizing seller’s discretionary earnings and/or EBITDA:
SDE is often the clearest signal for owner-operator companies because it captures the total economic benefit available to a working owner.
EBITDA is more useful as the company becomes less owner-dependent and operates more like an investable asset.
Two common errors show up in this step:
Double-counting add-backs. If a cost is already removed in the accounting presentation, adding it back again is duplication, not normalization.
Ignoring working capital needs. Even stable businesses require cash to fund receivables, inventory, payroll timing, and seasonality. If a model assumes working capital is “free,” it overstates the cash available to a buyer.
The practical closing thought: a clean cap-of-earnings result is less about squeezing the highest number possible, and more about producing a number a buyer can trace and trust.
Discounted Cash Flow (When Growth And Investment Matter)
The discounted cash flow (DCF) method becomes useful when last year is a poor proxy for next year. Rapid growth, meaningful reinvestment, a turnaround, or a business recovering from a temporary dip can all justify a DCF because it forces assumptions into the open.
DCF is straightforward in concept: forecast cash flows and discount them back to present value using a risk-adjusted discount rate. Where it goes wrong is also straightforward: forecasts become hope, and the discount rate becomes whatever makes the number work.
A defensible DCF usually includes:
Forecast discipline tied to actual drivers (capacity, pricing, churn, retention, and margins)
Sensitivity checks that show what changes the range (growth slows, margins tighten, customer acquisition costs rise)
A discount rate rationale that matches the real risk in the cash flows
This is the point where market reality should keep the model honest. Even when DCF is the right tool, it should be sanity-checked against what similar businesses trade for using market comps and valuation multiples.
Future Maintainable Earnings (FME), Simplified
Future maintainable earnings (FME) is the practical compromise for smaller companies that are stable, but not stable enough to pretend a five-year forecast is precise. FME aims to estimate a maintainable earnings level, then value that earnings stream without forcing a full DCF build.
FME tends to fit when the business is predictable in the ways that matter, but noisy in the details:
The revenue base is durable (repeat customers, renewals, or sticky contracts).
Costs fluctuate, but margins are broadly stable over time.
The historical record is clean enough to normalize, even if it is not clean enough to forecast line-by-line.
The closing thought: maintainable should be grounded in evidence (retention, churn, and margin durability), not in a feeling that the business is “pretty steady.”
The Market Approach: Let Comparable Sales Set The Range
The market approach is popular in small business transactions because it reflects what buyers are paying right now, not what sellers wish buyers were paying. In many categories, it is also the fastest way to arrive at a reality-checked range because it anchors value to comparable deals.
This section explains how market approach valuation works in practice, and why the comp set matters more than the headline multiple.
SDE And EBITDA Multiples, Explained
In the small business world, pricing often starts with multiples applied to SDE or EBITDA:
SDE multiples are most common for owner-operated businesses because the buyer is underwriting an owner job plus profit.
EBITDA multiples become more relevant as a business grows, has management in place, and looks more financeable.
Multiples are not magic. They are shorthand for risk, transferability, and documentation quality. That’s why a “same industry” comp can still be the wrong comp if the underlying risk profile is different.
For a structured framework on how multiples relate to fundamentals and when certain multiples fit certain valuation problems, the CFA Institute’s refresher reading on market-based valuation is a strong grounding.
This is where quality of earnings shows up as more than a diligence buzzword. Buyers pay for earnings that are repeatable, transferable, and documentable. If earnings “work” only when the seller is present, or only when the books are interpreted generously, the multiple drops. Even when the headline multiple stays the same, buyers often shift risk into structure through deal terms.
Rules Of Thumb Vs Real Signals
Rules of thumb are fine for a first pass. They become a problem when they become the pricing strategy.
A quick heuristic can help an owner understand whether they are in the right neighborhood. But getting to a defensible range requires verified comps and clean inputs:
Verified comparable sales data (not just listing prices)
Normalized SDE/EBITDA that ties back to bank statements and tax returns
A clear understanding of business-specific risk factors, such as customer concentration, owner dependence, and clean operational documentation
For a broader lens on how private market participants think about required returns, risk, and deal conditions, Pepperdine’s 2024 Private Capital Markets Report is a useful reference point.
The closing thought: market comps are only as persuasive as the match quality, and “same industry” is rarely specific enough.
The Asset Approach: Establishing The Floor
Some businesses are better explained by what they own than by what they earn, especially when tangible assets drive value or when profitability is weak or volatile. In those cases, the asset approach helps establish the floor and clarifies what a buyer is truly acquiring beyond customer relationships and cash flow.
This section covers the two most common asset-based lenses owners encounter.
Adjusted Net Asset Method
The adjusted net asset method starts with the balance sheet, then adjusts assets and liabilities to fair market value rather than accounting book value. This is where depreciation schedules stop being “the answer” and start being just one input.
In practice, the work usually includes:
Revaluing equipment and vehicles to current market reality
Treating leases correctly (especially when leased equipment is discussed like owned equipment)
Accounting for contingent liabilities that do not show up cleanly in everyday bookkeeping
For asset-heavy businesses, this method can meaningfully influence the negotiation range, even when the final value is still anchored by earnings.
Liquidation Value And When Lenders Care
Liquidation value is the asset approach under a stricter assumption: assets are sold rather than used to generate future earnings. Orderly liquidation and forced liquidation are not interchangeable, and the difference matters most when financing is involved.
SBA-backed acquisitions are one common place where collateral and structure can pull the asset floor into sharper focus. The SBA’s official SBA SOP 50 10 guidance frames lender requirements for the 7(a) and 504 programs and influences how lenders evaluate risk and documentation.
Asset value often does not set the price, but it frequently shapes what is financeable and how conservative a buyer will be.
Choosing The Right Approach For Your Business Type
Valuation confusion is usually less about math and more about mismatching the approach to the business model and buyer pool. A stable owner-operated service company should not be valued as if it were a fast-scaling subscription product, and an equipment-heavy manufacturer should not be valued as if assets are irrelevant.
This section maps common business types and stages to the approaches that tend to fit them best.
Service, Retail, Manufacturing, And Online
Different models pull valuation toward different anchors:
Service: owner involvement and SDE normalization matter most. Buyers are underwriting whether the cash flow survives the ownership change.
Retail: inventory turns, location risk, and demand durability matter. Working capital swings can materially affect cash availability.
Manufacturing: equipment value, backlog, margins, and customer relationships matter. Asset value often sets a meaningful floor.
Online/subscription: cohort durability, churn, retention, and marketing efficiency matter. FME or DCF can add clarity when growth and reinvestment meaningfully change the future.
The “best” valuation method is the one that reflects how the buyer will actually underwrite risk and transferability.
Stage And Stability
Stage nudges the weighting:
Young and growing: DCF can be useful if assumptions are defensible and evidence-backed.
Mature and stable: capitalization and market comps often carry more weight.
Declining or distressed: asset approaches and downside-protection structures rise in importance.
This is also why owners searching for how to value a business should separate planning value from transactional value. The buyer is pricing verification and transferability as much as performance.
Reconciling Methods: Arriving At A Defensible Range
It is normal for methods to disagree. Disagreement usually signals something important, such as growth that comps do not capture, volatility that capitalization smooths over, or asset intensity that earnings-based methods underweight.
A practical reconciliation process tends to look like this:
Identify why the methods diverge (growth profile, volatility, asset intensity, owner dependence, or documentation quality).
Weight methods based on what the most likely buyer pool will use.
Document assumptions so the range can survive diligence.
For example, a stable owner-operated HVAC company might weight cap-of-earnings and SDE multiples, then use an asset floor as a sanity check. A larger, manager-run company might weight comps and EBITDA multiples more heavily, especially if financing is central to the buyer pool. A distressed asset-heavy business might treat liquidation value as the anchor.
Reconciliation is not about forcing agreement. It is about making the reasons for disagreement explicit, then translating them into a range that holds up under scrutiny.
From Valuation To Deal Terms: Why Structure Beats Sticker
Price is only half the story. Structure determines what the seller actually takes home and how much risk stays behind after close.
This is where negotiations often become less about the headline multiple and more about “effective price.”
Common structures that change outcomes include:
Working capital pegs that adjust price based on delivered net working capital
Earnouts that shift part of the price into future performance
Holdbacks that protect buyers against post-close surprises
Seller financing that can expand the buyer pool, but changes timing and certainty
A higher headline price can be less attractive if the structure shifts too much risk back to the seller.
Data To Gather Before You Value
Better inputs make every valuation approach more accurate, and they also shorten diligence later. Clean documentation is often the invisible driver behind smoother negotiations, better buyer confidence, and fewer post-offer retrades.
Before valuing, owners should gather:
Three years of P&L and balance sheets
Tax returns that align with reported performance
Accounts receivable and accounts payable aging
Payroll records and owner compensation details
Key contracts, lease agreements, and customer concentration data
Inventory details (valuation method, obsolescence reality), when relevant
Then normalize:
One-time expenses and non-operating items
Discretionary owner expenses that a buyer can reasonably adjust
Anything non-transferable that temporarily boosted margins
This is where standardized financials for faster diligence stops being a slogan and becomes leverage. Buyers can move faster because they can verify faster.
Quick Examples To Make It Concrete
Examples are where valuation stops feeling theoretical and starts feeling usable. The goal here is not to prescribe one “correct” answer, but to show how different businesses naturally pull toward different methods, and how cross-checking creates a defensible range.
Owner-Operated HVAC With Stable SDE
Primary lens: cap-of-earnings on normalized SDE
Cross-check: market comps using SDE multiples
Floor: adjusted net asset value for trucks, equipment, and inventory
Resulting story: stable cash flow plus credible transferability, with assets supporting downside.
Seasonal eCommerce With Inventory Investment
Primary lens: DCF because seasonality and inventory investment change cash availability
Cross-check: comps on revenue and EBITDA where they make sense
Key diligence focus: working capital swings and customer acquisition volatility
Resulting story: value is real, but it is sensitive to demand durability and margin stability.
Fabrication Shop With Heavy Equipment
Primary lens: adjusted net assets to establish the floor
Cross-check: EBITDA multiple comps, adjusted for backlog and concentration risk
Financing lens: liquidation value can matter if lender comfort is central
Resulting story: assets matter, but the multiple depends on whether earnings are durable and transferable.
What Improves Your Valuation Before You List
The best pre-sale improvements are not cosmetic. They reduce uncertainty across the income, market, and asset lenses, which is why they tend to lift value and reduce diligence friction at the same time.
A few high-impact moves that frequently help:
Cleaner monthly reporting and reconciled accounts
Reduced customer concentration and documented renewal behavior
Documented SOPs that reduce owner dependence
Renewed key contracts where practical
A clear working-capital narrative that matches how the business actually operates
For sellers who want a quick baseline range before doing deeper work, Baton’s business valuation calculator can help ground expectations with a fast, free business valuation benchmark.
The goal is not to “prep for valuation.” It is to make the business easier to trust, which usually makes it easier to finance and easier to close.
Make Your Valuation Work For You
A strong valuation is not a single number someone “wins.” It is a defensible range backed by the right approach for the business, the buyer pool, and the available data.
In practice, that often means combining methods:
Using income lenses when cash flow is steady or when growth and reinvestment truly change the future
Using market comps to anchor expectations to current pricing behavior
Using asset lenses to establish the floor and understand financing constraints
If revenue is the only clean metric available today, how to value a company often starts with revenue based valuation, then moves to cash-flow grounding as documentation improves.
For owners deciding how formal their valuation process needs to be, the distinction between business appraisal vs valuation can clarify whether the situation calls for a formal report or a defensible market range.
And for teams that want valuation support that stays practical and transaction-oriented, Baton’s small business valuation resources are built to keep the process simple, transparent, and grounded in how buyers actually evaluate risk.