How to properly value a small business - a 2025 guide that won't change in 2026

[JohnnyDoe]

This is a practical, academically grounded playbook for founders, buyers, and investors. It blends business school methods (DCF, income capitalization, market and asset approaches), practitioner tools (quality of earnings, working-capital pegs, DLOM/Control premiums), and operator heuristics. Use it to produce a defensible valuation range, not a fairy-tale number that collapses in diligence.

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1) Start with the “what” you’re valuing​

Before touching a calculator, lock these four fundamentals. Every serious valuation report states them up front.

• Standard of value: usually Fair Market Value (FMV) or Investment Value.
• Premise of value: going concern vs. orderly/liquidation.
• Level of value: controlling vs. minority interest (matters for premiums/discounts).
• Valuation date: as-of date drives data cut and discount rates.

If you can’t specify all four in one sentence, you’re not ready to calculate anything.

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2) Clean the numbers: Normalization checklist​

Small-business books are messy. Normalize so operating performance reflects reality.

1. Revenue quality
   
   • Separate recurring vs nonrecurring.
   • Remove one-off projects, COVID grants, lawsuit proceeds.
     
2. COGS and OpEx
   
   • Back out owner perks, personal expenses, related-party rent at above/below-market, one-time legal fees, restructuring.
   • Normalize wages to true market comp for each role.
     
3. Working capital
   
   • Compute a normalized working-capital requirement (e.g., % of next-twelve-months revenue).
   • Identify customer concentration and AR aging issues.
     
4. Capex & depreciation
   
   • Align depreciation life with economic reality; model maintenance vs growth capex.
     
5. Taxes
   
   • For income approaches, use tax-affected cash flows (even for pass-throughs) so your discount rate and peers are apples-to-apples.

Deliverables from this step:

• Trailing 36 months monthly P&L and cash flow
• Normalized EBITDA and SDE bridges
• Normalized working-capital baseline
• Maintenance vs growth capex map

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3) Pick the right approaches (use at least two)​

A) Income Approach​

i) Single-period capitalization of cash flows
For stable businesses growing at a steady rate:

• FCFF₁ = next-year Free Cash Flow to Firm
• Enterprise Value (EV) = FCFF₁ / (WACC − g)

Where:

• WACC = weighted average cost of capital
• g = long-run growth (must be ≤ long-term GDP growth of your market)

ii) Multi-period DCF
For businesses with near-term ramp or cleanup:

• Forecast 3–7 years of FCFF, then a terminal value via Gordon Growth or an exit multiple you can defend with comps.

Cost of capital for private small firms (2025 reality):

• Start with CAPM or Build-Up:
  
  • Risk-free rate
    • Market risk premium
    • Size premium (small-cap)
    • Specific company risk (customer concentration, key-person risk, supplier fragility, cyclicality, weak controls)
  • Tax-affect, blend with target leverage to get WACC.

B) Market Approach​

i) Guideline public companies (GPC):
Use when genuine peers exist; adjust for size, growth, and private-company discounts.

ii) Guideline transactions (M&A comps):
Best signal for small businesses if data quality is decent. Focus on EV/EBITDA, EV/Revenue, EV/SDE and deal terms (earn-outs, seller notes).

Market multiples are not laws of physics. Size, growth durability, and concentration are the biggest drivers of spread.

C) Asset-Based Approach​

Adjusted Net Asset Value for asset-heavy firms or when earnings are unreliable. For service/asset-light firms, this is a floor, not a destination.

D) Economic Profit / Residual Income (advanced but powerful)​

Value today’s invested capital at replacement cost, then add PV of future economic profit (ROIC − WACC) × Invested Capital. Excellent for teasing apart businesses with similar EBITDA but different capital intensity.

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4) Discounts and premiums (don’t skip them)​

• Control premium (apply when valuing a controlling interest): access to cash flows, set strategy, replace management.
• DLOM (Discount for Lack of Marketability): private shares are illiquid. Typical 10–35% depending on facts and restrictions.
• Minority interest discount: if valuing a non-controlling stake.
• Key-person risk / customer concentration add-on: can be modeled in cash flows or as company-specific risk in discount rate. Do not double-count.

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5) A simple, calculator (with example)​

Inputs​

• Revenue next year: 2,000,000
• EBITDA margin: 15% → EBITDA = 300,000
• Depreciation: 50,000
• EBIT = 300,000 − 50,000 = 250,000
• Cash tax rate: 25% → NOPAT = 250,000 × 0.75 = 187,500
• Maintenance Capex: 60,000
• Δ Working capital (increase): 10,000
• FCFF (Year 1) = NOPAT + Depreciation − Capex − ΔWC
  = 187,500 + 50,000 − 60,000 − 10,000
  = 167,500

Assume long-run growth g = 3% and WACC = 16% for a small private firm with some concentration risk.

• FCFF₁ grown one year: 167,500 × 1.03 = 172,525
• EV ≈ 172,525 / (0.16 − 0.03) = 172,525 / 0.13 = 1,327,115
• Subtract net debt (say 200,000) → Equity value ≈ 1,127,115
• If you’re buying a controlling interest, you might apply a control premium; if valuing a minority stake, consider DLOM/minority discounts instead.

Sanity check with a market multiple:

• If normalized EBITDA is 300,000 and the defendable multiple is 3.5×, EV = 1,050,000.
• Your income approach is higher (1.33m). Investigate the gap: perhaps your WACC is too low, or multiples reflect recent softening in your niche. Tighten assumptions and converge to a range, not a point.

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6) Industry lenses (what actually moves the needle)​

• SaaS / subscriptions: ARR, Net Revenue Retention, Gross margin, CAC payback, LTV/CAC, Net dollar retention. Multiples track durability of ARR and margin trajectory far more than absolute size.
• E-commerce: Cohort economics, repeat rate, contribution margin after ads, inventory turns, dependence on a single channel.
• Services/consulting: Contracted backlog, utilization, billable mix, churn of top 10 clients, depth of team beyond founders.
• Local brick-and-mortar: Lease quality, footfall durability, labor sensitivity, transferable playbooks, unit economics per site.
• Regulated professional firms: Retention and portability of clientele, partner comp normalization, non-competes.

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7) Deal terms that change “price” versus “value”​

• Working-capital peg: buyers expect a normalized level delivered at close; shortfalls reduce price dollar-for-dollar.
• Earn-outs: increase headline price, shift risk to seller; discount earn-outs in your valuation unless probability-weighted.
• Seller notes / rollover equity: reduce cash at close but can raise total consideration if the business performs.
• Employment/Non-compete: materially impact risk; you can price them through lower WACC or higher sustainable growth if they de-risk key-person issues.

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8) Quality of Earnings (QoE) essentials​

A QoE report is not a tax return review. It validates economic earnings and cash conversion.

• Rebuild revenue by cohort/sku/channel.
• Reconcile add-backs with evidence.
• Tie EBITDA to cash: EBITDA − ΔWC − Capex ≈ operating cash.
• Prove customer concentration is stable with 24–36 month data.
• Trace related-party transactions to market benchmarks.

If your number collapses under QoE, your “valuation” was fiction.

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9) Common errors and avoidable face-plants​

1. Applying a multiple to the wrong metric. EV/EBITDA vs Price/SDE vs EV/Revenue aren’t interchangeable.
2. Using broker “rules of thumb” without size, quality, and growth adjustments.
3. Double-counting risk, once in WACC and again via heavy DLOM or bearish cash-flow haircuts.
4. Ignoring working capital. Businesses that “grow broke” look profitable until the cash calls arrive.
5. Pretending owner dependence isn’t a thing. If clients only pick up when you call, buyers discount hard.
6. Terminal value madness. g cannot exceed the economy’s long-term growth. Ever.
7. Cherry-picking one good year instead of using multi-year averages and run-rate proofs.
8. Capex delusion. Starving the asset base to boost EBITDA is not free money; buyers will normalize capex.
9. No sensitivity analysis. If a 1% change in WACC moves value by 20% and you don’t show it, expect a haircut.
10. Forgetting the level of value. Minority stakes with transfer restrictions are not priced like controlling interests.

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10) Step-by-step workflow you can actually follow​

1. Define standard, premise, level, date.
2. Collect 36 months financials; build normalization bridges to SDE and EBITDA.
3. Map working-capital needs and capex.
4. Choose methods: Income (cap or DCF) + Market (GPC/transactions). Use Asset-based as a floor if relevant.
5. Estimate discount rate (Build-Up), terminal growth, and near-term growth by driver analysis, not vibes.
6. Triangulate. Explain divergences between methods.
7. Apply appropriate discounts/premiums based on the level of value.
8. Run sensitivity and scenario cases (Bear / Base / Upside).
9. Document assumptions and evidence.
10. Package as a range with midpoint, not a single magic number.

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11) Ready-to-use calculator blueprint​

Inputs:

• Next-year revenue, gross margin, OpEx, Depreciation, Capex (maintenance and growth), ΔWC, tax rate
• WACC, long-run growth g
• Net debt, ownership level (control/minority), marketability constraints

Core formulas:

• EBIT = Revenue × margin − OpEx − Depreciation
• NOPAT = EBIT × (1 − tax)
• FCFF = NOPAT + Depreciation − Capex − ΔWC
• EV (cap method) = FCFF₁ / (WACC − g)
• Equity = EV − Net Debt
• Apply DLOM/minority or control adjustments based on the defined level of value

Outputs:

• EV and Equity value range (sensitivity on WACC ±2%, g ±1%, margins ±2 pts)
• Bridge from accounting EBITDA/SDE to economic FCFF
• Implied trading and transaction multiples for sanity check

Drop this into a spreadsheet and you’ve got an audit friendly calculator in under an hour.

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12) How to increase valuation in 90–180 days​

• Replace owner-operator risk: document processes, delegate client relationships, install a #2.
• Tilt to recurring revenue: convert projects to small retainers where possible.
• Normalize working capital: enforce payment terms, reduce AR >60 days, negotiate supplier terms.
• Lock in key accounts: multi-year contracts, renewal options, and price-increase clauses.
• Clean legal/admin: IP assignment, employee/contractor agreements, non-competes, licenses current.
• Prove cash conversion: publish a 24-month EBITDA-to-cash bridge in your data room.
• Prepare a QoE-ready trial balance: your “add-backs” should be bullet-proof, not creative writing.

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13) References worth reading​

• Koller, Goedhart, Wessels. Valuation (McKinsey).
• Damodaran. Investment Valuation and datasets on discount rates.
• Pratt. Valuing a Business and Cost of Capital.
• Petersen & Plenborg. Financial Statement Analysis and Valuation.
• AICPA SSVS No. 1, IVS, and USPAP for valuation standards and reporting structure.

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FAQ (operator level answers)​

What’s the fastest credible method for a stable small business?
Single-period income capitalization using normalized FCFF with a justified WACC and g, cross-checked against transaction comps.

SDE or EBITDA?
Use SDE for truly owner-operated micro-businesses; use EBITDA for businesses that can support market-rate management.

What multiple should I use?
Start with comps, then adjust for size, durability of cash flows, and concentration. If you can’t evidence peers, don’t anchor to a number you found in a forum.

How often should I revalue?
Annually or upon material change: major contract wins/losses, channel shifts, pricing resets, leadership changes.

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One-page baluation template​

• Standard/Premise/Level/Date: …
• Business model & revenue mix (recurring vs nonrecurring): …
• Normalization bridges (SDE and EBITDA): …
• Working-capital baseline (% of NTM revenue): …
• Capex (maintenance vs growth): …
• Methods used and why: …
• WACC build-up and g rationale: …
• Income approach value: …
• Market approach value: …
• Adjustments (control/DLOM/minority): …
• Sensitivities and scenarios: …
• Final range and midpoint: …

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Value is a range anchored in cash flows, risk, and market evidence. If your number depends on ignoring working capital, pretending your spouse’s SUV is a “delivery vehicle,” or hoping buyers won’t notice that one client is 62% of revenue, then it’s a fantasy story ready to collapse at first scrutiny.

 

[Marty McFly]

This is so much better than the OffshoreCorpTalk guide on the same subject 👍