Valuing a small business is one of those tasks that sounds technical but is actually quite logical once you understand the three main methods. Whether you are buying a business, preparing to sell one, or settling a dispute between partners, the goal is the same: arrive at a defensible number that reflects what the business is genuinely worth.
Method 1: The earnings multiple (fastest)
The most common quick method is to multiply the business's annual earnings by a number that reflects how similar businesses have sold. For most small businesses, that multiple is somewhere between two and five times the annual net profit or EBITDA (earnings before interest, taxes, depreciation, and amortisation).
A cafe or retail shop might sell for two to three times annual profit — reflecting the risk and effort of running it. A professional services firm with recurring contracts might sell for four to five times. A technology business with predictable subscription revenue might sell for eight to ten times. The multiple reflects how confident a buyer is that the earnings will continue.
The limitation of multiples is that they tell you what businesses have sold for, not what they are worth. In a hot market, buyers pay inflated multiples. In a slow market, multiples compress. Always combine a multiple valuation with the next method.
Method 2: Discounted cash flow (most rigorous)
The DCF method asks: if you bought this business and received its cash flows for the next five to ten years, then sold it, what would that be worth in today's money at your required rate of return? This is mathematically precise and reflects the economic reality that money now is worth more than money later.
To run a DCF, you need three inputs: the annual free cash flow (not profit — the actual cash the business generates after reinvestment), a growth rate for those cash flows, and a discount rate. For a small business, a discount rate of 15–20% is realistic. This reflects the risk premium a buyer demands for taking on a concentrated, illiquid, owner-operated business.
The DCF is the preferred method for serious buyers and for businesses with predictable cash flows. It is less useful for highly seasonal businesses or ones in early growth phases.
Method 3: Asset-based valuation (for asset-heavy businesses)
For businesses where the value lies in what they own — property, equipment, inventory, intellectual property — an asset-based valuation may be more appropriate. This method takes the fair market value of all assets and subtracts all liabilities. The result is the net asset value.
Asset-based valuation is common for property businesses, manufacturers, and businesses being wound down. For service businesses and retail, it usually understates value significantly, because the business's worth lies in its customer relationships and brand — neither of which appear on the balance sheet.
Which method should you use?
Use all three as a cross-check. If the multiples method gives $300,000, the DCF gives $280,000, and the asset-based method gives $150,000, the market evidence suggests a range of $280,000–$300,000 — and the asset-based value confirms there is meaningful goodwill in the business beyond its physical assets.
If one method gives a dramatically different answer, investigate why. A high DCF relative to the multiple might mean the business has unusually strong growth prospects that the market has not yet recognised. A high multiple relative to the DCF might mean the market is overheated or buyers are pricing in synergies you should not be paying for.
What reduces a business's value
- Revenue concentrated in one or two customers (concentration risk)
- Cash flows dependent on the owner's personal relationships or skills
- No written contracts with key customers or suppliers
- Inconsistent or declining cash flows over the past three years
- Industry facing structural disruption (e.g., physical retail)