How valuation multiples work, and what actually moves yours
Every owner has heard businesses sell for a multiple. Almost nobody is told what decides whether theirs is a two or a four.
What is a valuation multiple?
A multiple is the number you multiply annual earnings by to get a sale price. A business earning $200,000 that sells at a 3x multiple is worth $600,000. That is the entire arithmetic. Everything interesting is in why one business gets a 2 and another gets a 4 on identical earnings.
What multiple do small businesses sell for?
Most small owner-operated businesses trade between 2 and 4 times seller's discretionary earnings. Below about $200,000 of earnings, multiples cluster lower, because the pool of buyers is people buying themselves a job and financing is harder. Above roughly $1 million, businesses start being valued on EBITDA instead and the multiples rise, because larger buyers with cheaper capital enter the market.
What raises a multiple?
Anything that makes the earnings more likely to continue after the owner leaves. In rough order of how much each one moves the number:
- The owner is not required day to day, because a manager or team already runs it
- Revenue is recurring or contracted rather than won job by job
- No single customer is worth more than about 10% to 15% of revenue
- Three years of clean books that reconcile with the tax returns
- Documented processes, so a new owner can learn the business from paper rather than from the seller
- Stable or growing revenue over three years
What lowers a multiple?
Owner dependence, above everything else. If the customers buy because of you, if the pricing lives in your head, if the key supplier relationship is your friendship, then a buyer is not purchasing a business, they are purchasing the hope of rebuilding one. That gets discounted hard. The other reliable discounts are customer concentration, declining revenue, a lease that expires soon, and financial records a lender cannot verify.
Why do two similar businesses sell for different multiples?
Because the multiple prices risk, not size. Take two businesses each earning $300,000. One is a service company where the owner is the lead salesperson and the top client is 45% of revenue. The other has a manager, forty clients and a two year contract with most of them. The second sells for materially more money on identical earnings, and both prices are rational.
How do you actually raise your multiple?
Start two to three years before you sell, because buyers pay for changes they can verify in results. The changes that matter all take time to appear in the numbers. Promoting a manager and stepping back shows up as a business that ran without you for eighteen months. Diversifying customers shows up as a concentration figure that improved. Cleaning up bookkeeping shows up as three consecutive years that reconcile. A change made in the month before listing shows up as nothing, because there is no history behind it yet.
Should you get a formal valuation?
For a rough range, a calculator is enough. For a price you will defend, get an appraisal. An SBA lender will require an independent valuation before funding anyway, so on a financed deal one is happening regardless. Getting your own earlier gives you a defensible number to negotiate from and tells you which of the factors above is costing you the most.
What to change in the two years before you sell, and how each change shows up in the multiple a buyer offers. One email, no course.
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Common questions
Do multiples vary by industry?
Yes, considerably. Businesses with recurring revenue and low capital needs, such as service contracts or software, tend to command higher multiples than businesses with heavy equipment, thin margins, or a heavy dependence on one skilled operator.
Does inventory get added to the price?
Often, and it is worth agreeing early. In many small business sales the multiple buys the operating business and saleable inventory is priced separately at cost. Leaving this vague until closing is a common source of last-minute arguments.
Can you sell for more than the multiple suggests?
Yes, most often to a strategic buyer. A competitor or supplier who gains something you do not have, a territory, a customer list, a capability, may pay above the financial value because the business is worth more inside theirs than on its own.
What if the business is losing money?
Then it sells on the value of its assets rather than its earnings, which is usually much less. If the business is near break-even, a year spent getting it clearly and verifiably profitable typically returns far more than it costs.