One of the most common questions we receive from business owners considering a sale is: 'What is my business actually worth?' It is a reasonable question, and the answer is more straightforward than most people expect.
Here is a plain-English guide to how service businesses are valued.
The Foundation: Seller's Discretionary Earnings (SDE)
For small service businesses, typically those with revenues under $5 million, the most commonly used valuation metric is Seller's Discretionary Earnings, or SDE.
SDE represents the total financial benefit that a working owner-operator receives from the business in a given year. It starts with net income and adds back:
- Owner's salary and benefits
- Owner's personal expenses run through the business (vehicle, phone, travel)
- Non-recurring or one-time expenses (equipment purchases, legal fees)
- Depreciation and amortization
- Interest expense
If your business generates $400,000 in net income, and you pay yourself a $150,000 salary and run another $25,000 in personal expenses through the business, your SDE is approximately $575,000.
The Multiple: What Buyers Pay Per Dollar of SDE
Once SDE is established, buyers apply a multiple to arrive at a purchase price. For small service businesses, this multiple typically ranges from 2.5x to 4.0x SDE, depending on the quality of the business.
Factors that increase your multiple:
- Long operating history (10+ years) with consistent or growing revenue
- Recurring or contracted revenue rather than project-based work
- Diversified customer base: no single customer over 20% of revenue
- Trained, tenured management team that reduces key-person dependency
- Clean financial records going back at least three years
- Proprietary brand, territory, or licensing position
Factors that reduce your multiple:
- Heavy key-person dependency: the business cannot run without you
- Customer concentration: one customer is 30% or more of revenue
- Declining revenue trend in the past 1-2 years
- Deferred maintenance on equipment or facilities
- Messy or inconsistent financial records
A Real-World Example
Let us say you own a pest control company. Over the last three years, you have averaged $320,000 in annual SDE. Your revenue has grown modestly each year. You have 1,200 recurring residential accounts. No single customer is more than 2% of revenue. Your financial records are clean.
At a 3.5x multiple, your business would be valued at $1,120,000. At 3.8x, $1,216,000. The difference of $96,000 between those two multiples is almost entirely determined by the quality factors listed above: things you can influence before you go to market.
EBITDA for Larger Businesses
For businesses with revenue above $2-3 million, particularly those with employees who handle management functions the owner does not, buyers often shift from SDE to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). EBITDA multiples for service businesses in this range typically run 4x to 6x.
The key difference: EBITDA is calculated on a 'market rate' salary for the owner's role, not on what the owner actually pays themselves. This standardizes comparisons across businesses.
What This Means Practically
If you are three to five years from selling, understanding your current SDE and the factors that affect your multiple gives you a roadmap for increasing your business value before you go to market:
- Reduce key-person dependency: hire and train a manager
- Diversify your customer base if you have concentration risk
- Clean up your financial records and work with a good CPA
- Document your processes so the business can run without you
- Grow recurring revenue: contracts and subscriptions command premium multiples
SDE = Net Income + Owner Compensation + Owner Perks + Depreciation & Amortization + Interest + Non-Recurring Expenses