Small Business Valuation: A Simple Guide for First-Time Buyers

Thinking about buying a business for the first time? Whether you're looking at a local service company, a retail shop, or an online brand, one of the most important things to understand is how the business is valued. Get this wrong, and you could overpay—or walk away from a great opportunity.

The good news? You don’t need to be a financial expert to understand the basics of small business valuation. In this guide, you’ll learn what SDE and EBITDA really mean, how they’re used in different types of deals, and what to look out for when reviewing a business’s financials.

What is Business Valuation? 

Business valuation is the process of figuring out what a business is worth. The final price is usually based on how much money the business makes, its future earning potential, and what assets or systems come with it.

For small to mid-sized businesses, this often involves one of two financial metrics that are commonly used to assess a going-concern business in practice:

• SDE: Seller’s Discretionary Earnings

• EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization

Knowing which one applies to the business you’re evaluating is essential to understanding the true value—and what you’re actually buying.

SDE vs. EBITDA: What’s the Difference?

SDE: Seller’s Discretionary Earnings

SDE is the most common metric used in small business valuation, especially for owner-operated or lifestyle businesses. These are typically companies where the owner works in the business every day and may run personal expenses through it.

• SDE starts with the business’s profit and then adds back:

• The owner’s salary

• Personal benefits (like insurance or travel)

• One-time expenses

• Any discretionary or non-essential costs

SDE gives buyers a clearer picture of the total financial benefit they could expect to receive if they step in and run the business themselves.

When a business is priced based on SDE multiples, the valuation is derived by multiplying the adjusted SDE by an industry-specific multiple. 

For example, if a business generates $250,000 in SDE and the industry standard multiple is 2.5x, the business would be valued at: 

$250,000 × 2.5 = $625,000 

EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization

EBITDA is more commonly used in low to mid-market business valuation. These are typically businesses with $2M+ in annual revenue, a management team in place, and minimal reliance on the current owner.

EBITDA provides a standardized view of a business’s profitability by removing the effects of financing and accounting decisions. It’s the go-to metric for banks, private equity firms, and corporate buyers, assuming the business does not have require a great deal of capital expenditures to operate and maintain the business.

Which Should You Use?

Use SDE when evaluating small, owner-managed businesses where you’ll be taking over the owner’s role.

Use EBITDA for larger, more structured businesses where you plan to step in as an investor or hire managers to operate it.

Understanding the difference helps you assess the business on the right terms—and avoid overestimating its profit potential.

Factors that influence an earnings multiple include: 

• Industry type and trends

• Size and profitability of the business

• Customer diversity and revenue stability

• Operational efficiency

• Dependence on the owner

• Market demand for similar businesses

  
  

Understanding the SDE multiple ensures that you are not overpaying for a business and helps you compare different opportunities within the same industry. 

What Does Cash-Free, Debt-Free Mean? 

When a business is listed as being sold on a cash-free, debt-free basis, this means: 

• The seller will retain all cash in the business at closing. 

• The buyer will not assume any of the business’s existing debt. 

  
  

Essentially, the purchase price is based solely on the business’s assets, goodwill, and profitability, without the impact of previous financial obligations or excess cash reserves. 

No Working Capital Included – Why It Matters 

Some businesses are sold without working capital, which can be a costly surprise if you're not prepared.

Working capital usually includes:

• Inventory

• Accounts receivable (customer payments owed)

• Accounts payable (bills the business owes)

  
  

If this isn’t included in the deal, you’ll need to inject your own cash immediately to cover operations. Make sure to ask the seller if working capital is part of the sale—and if not, plan to bring additional funds.

Why This Knowledge is Essential When Buying a Business 

If you're new to buying a business, understanding the difference between SDE and EBITDA—and what’s included in the deal—can make or break your success. Here's why it matters:

1. Confusing SDE and EBITDA can lead to dramatically overvaluing a business. Know which one is being used before you commit to a price.

2. Working capital, equipment, customer contracts—know what’s included and what’s not, so you’re not caught off guard after closing.

3. Lenders use EBITDA to determine how much debt a business can support. If you're relying on a loan, this number matters and not SDE.

4. If the deal doesn’t include cash, inventory, or receivables, you’ll need extra capital to fund the first few months of operations.

5. Knowing how small businesses are valued gives you leverage when negotiating price and terms.

Book a free consultation today and take the first step with confidence.

Disclaimer:

This blog post is intended for informational purposes only and does not constitute legal, financial, or tax advice. Always consult with a qualified professional before making decisions related to business purchases or valuations.