Business Valuation Methods Explained
EBITDA multiples, DCF, and asset-based approaches for private companies
Key Takeaways
- •Three main valuation approaches: market (multiples), income (DCF), and asset-based
- •EBITDA multiples are the most common method for established private companies
- •Private companies trade at a discount to public comparables due to liquidity and risk
- •Valuation is both science and art—the same company can have different values to different buyers
- •Understanding valuation methods helps you maximize value before going to market
Understanding how buyers value businesses is essential whether you're planning an exit, evaluating an acquisition, or simply want to understand what drives your company's worth.
This guide covers the three main valuation approaches used for private companies: the market approach (comparable transactions and multiples), the income approach (discounted cash flow), and the asset-based approach. We'll explain when each is used, typical valuation ranges by industry, and what factors drive differences in value.
Valuation Reality
A business is ultimately worth what a buyer will pay for it. Valuation methods provide frameworks and benchmarks, but the final price depends on buyer motivation, competitive dynamics, and negotiation. Understanding the methods helps you position for maximum value.
The Three Valuation Approaches
Appraisers and M&A professionals typically consider three approaches when valuing a business. Each has strengths and is appropriate in different situations.
Market Approach
Values the business based on what similar companies have sold for. Uses comparable transactions and trading multiples.
Best for: Established companies with comparable transactions available
Income Approach
Values the business based on its expected future cash flows, discounted to present value. Includes DCF and capitalization of earnings methods.
Best for: Companies with predictable cash flows and growth trajectories
Asset-Based Approach
Values the business based on the fair market value of its assets minus liabilities. Can be on a going-concern or liquidation basis.
Best for: Asset-heavy businesses, holding companies, or as a floor value
In practice, sophisticated buyers and appraisers use multiple methods and triangulate to arrive at a valuation range. The weight given to each approach depends on the specific circumstances of the business and transaction.
Market Approach: Multiples and Comparables
The market approach values a business based on what similar companies have sold for. It's the most common method for M&A transactions because it reflects what buyers are actually paying in the market.
EBITDA Multiples
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) multiples are the standard currency for valuing established private companies. The formula is simple:
EBITDA Multiple Formula
Enterprise Value = Adjusted EBITDA x Multiple
Example:
$2M Adjusted EBITDA x 5.0x Multiple = $10M Enterprise Value
Typical EBITDA Multiples by Industry
| Industry | Typical Range | Key Drivers |
|---|---|---|
| Software/SaaS | 6x - 12x+ | Recurring revenue, growth rate, retention |
| Healthcare Services | 6x - 10x | Reimbursement stability, regulatory |
| Business Services | 5x - 8x | Contract length, client retention |
| Manufacturing | 4x - 7x | Margins, customer concentration, capex |
| Distribution/Wholesale | 4x - 6x | Supplier relationships, margins |
| Construction/Trades | 3x - 5x | Backlog quality, labor availability |
| Retail | 3x - 5x | Same-store growth, e-commerce |
| Restaurants | 3x - 5x | Unit economics, scalability |
Size Matters
These ranges apply to lower middle market companies ($5M-$50M revenue). Larger companies command higher multiples due to reduced risk and more buyer interest. A $50M EBITDA company will trade at a significant premium to a $2M EBITDA company in the same industry.
Revenue Multiples
Revenue multiples are used when EBITDA is negative, inconsistent, or when growth is more important than current profitability. They're common for high-growth companies and SaaS businesses.
Revenue Multiple Considerations
- SaaS/Recurring Revenue: 2x - 10x+ ARR depending on growth and retention
- Professional Services: 0.5x - 1.5x revenue
- Manufacturing: 0.3x - 0.8x revenue
- Distribution: 0.2x - 0.5x revenue
Revenue multiples vary more than EBITDA multiples because margins differ significantly by industry.
Comparable Transactions
The most relevant market data comes from comparable transactions—what similar companies actually sold for. Investment bankers and M&A advisors maintain databases of transaction multiples to benchmark valuations.
What Makes a Good Comparable
- Same or similar industry
- Similar size (revenue, EBITDA)
- Similar growth profile
- Similar geographic market
- Recent transaction (within 2-3 years)
Adjustments to Consider
- Size premium/discount
- Growth rate differences
- Margin differences
- Customer concentration
- Market timing (M&A cycles)
Income Approach: DCF and Capitalization
The income approach values a business based on its expected future economic benefits. The two main methods are Discounted Cash Flow (DCF) analysis and capitalization of earnings.
Discounted Cash Flow (DCF)
DCF analysis projects future free cash flows and discounts them to present value using a rate that reflects the risk of achieving those cash flows.
DCF Components
1. Projected Free Cash Flows
Typically 5-7 year forecast of cash available to all capital providers
2. Terminal Value
Value of cash flows beyond the projection period (often 50-70% of total value)
3. Discount Rate
Weighted average cost of capital (WACC) for public companies; higher rates for private
Private Company Discount Rates
Private companies require higher discount rates than public companies due to additional risk factors:
| Risk Factor | Premium | Explanation |
|---|---|---|
| Base Cost of Capital | 8-12% | Industry/public company baseline |
| Size Premium | 3-6% | Smaller companies = higher risk |
| Company-Specific Risk | 2-8% | Management, customer concentration, etc. |
| Typical Total Rate | 15-25% | For lower middle market companies |
Capitalization of Earnings
For stable businesses with predictable earnings and limited growth, capitalization of earnings provides a simpler alternative to DCF:
Capitalization Formula
Value = Normalized Earnings / Capitalization Rate
Example:
$1.5M Normalized Earnings / 20% Cap Rate = $7.5M Value
The capitalization rate is essentially the discount rate minus the expected growth rate.
DCF in Practice
While DCF is theoretically sound, it's highly sensitive to assumptions about growth rates, margins, and discount rates. Small changes in these inputs can dramatically change the output. Buyers often use DCF to validate multiple-based valuations rather than as the primary method.
Asset-Based Approach
The asset-based approach values a business based on the fair market value of its assets minus its liabilities. It can be applied on either a going-concern or liquidation basis.
Going Concern Basis
- Assets valued at fair market value in use
- Assumes business continues operating
- Includes intangible assets if identifiable
- Often sets a floor value
Liquidation Basis
- Assets valued at liquidation value
- Assumes forced or orderly sale
- Typically lower than going-concern
- Used for distressed situations
When Asset-Based Valuation is Appropriate
Asset-Heavy Businesses
Real estate holding companies, equipment rental, natural resources
Investment/Holding Companies
Companies whose value is primarily in their investments or real estate
Underperforming Businesses
When earnings don't justify asset values; sets a floor
Liquidation Scenarios
Bankruptcy, wind-down, or break-up analysis
Asset-Based Limitations
For most operating businesses, asset-based valuation understates true value because it doesn't capture the value of the business as a going concern—the value of customer relationships, trained workforce, systems, and goodwill. It's typically a floor value rather than what a buyer would pay.
What Drives Valuation Differences
Two companies in the same industry with similar EBITDA can have very different valuations. Understanding the factors that drive multiple expansion or compression helps you maximize value before going to market.
Factors That Increase Multiples
Growth
Strong historical growth (15%+) and clear growth runway commands premium multiples
Recurring Revenue
Subscription, contract, or repeat revenue with high retention is highly valued
Diversified Customers
No single customer >10% of revenue; broad customer base reduces risk
Strong Management
Professional management team that will stay post-acquisition
Margin Expansion
Above-industry margins or clear path to margin improvement
Scalable Model
Business can grow without proportional increase in costs/headcount
Factors That Decrease Multiples
Customer Concentration
Top customer >20% of revenue significantly reduces multiple
Owner Dependence
Business relies heavily on owner for sales, relationships, or operations
Declining or Flat Revenue
No growth or declining trends significantly compress multiples
Capital Intensity
High ongoing capex requirements reduce cash available to buyers
Industry Headwinds
Secular decline, regulatory risk, or technological disruption
Working Capital Intensity
High inventory or receivables requirements tie up cash
The Private Company Discount
Private companies trade at a discount to public company valuations. This discount reflects several risk factors that don't exist for publicly traded securities.
| Discount Factor | Typical Range | Explanation |
|---|---|---|
| Lack of Marketability | 15-30% | Can't easily sell shares; limited buyer pool |
| Size Discount | 5-15% | Smaller companies have higher risk profile |
| Control Premium (inverse) | 20-40% | Minority interests trade at discount to control |
| Total Discount Range | 20-40% | Depending on company characteristics |
Strategic Buyer Exception
Strategic buyers—companies acquiring for synergies—may pay closer to or even above public market multiples if the acquisition creates significant value through cost synergies, revenue synergies, or strategic positioning. This is why running a competitive process with multiple strategic buyers often yields the highest valuations.
Calculating Adjusted EBITDA
The EBITDA figure used for valuation isn't straight from your financial statements. Buyers calculate "adjusted" or "normalized" EBITDA to reflect the true ongoing earnings power of the business.
Common EBITDA Adjustments
+ Owner Compensation Above Market: If owner takes $500K but market rate for a CEO is $250K, add back $250K
+ Personal Expenses: Car payments, club memberships, family members on payroll not working
+ One-Time Costs: Litigation settlement, relocation, one-time consulting projects
+ Non-Recurring Items: Write-offs, restructuring costs, acquisition costs
- Below-Market Rent: If company occupies owner's building at below-market rent
- Unsustainable Revenue: One-time projects that won't recur
Quality of Earnings
Sophisticated buyers will conduct "Quality of Earnings" (QoE) analysis—essentially auditing your adjusted EBITDA calculation. Aggressive or unsupportable adjustments will be challenged or rejected. Work with your CFO or advisor to prepare defensible adjustments with documentation before going to market.
Practical Valuation Tips for Sellers
Know Your Adjusted EBITDA
Calculate and document your adjusted EBITDA before engaging with buyers. Have your accountant or CFO prepare a bridge from reported to adjusted EBITDA with supporting documentation for each adjustment.
Understand Your Comparables
Research recent transactions in your industry. Your investment banker can provide this, or you can find data through industry publications and M&A databases. Know where you should fall in the range and why.
Address Value Detractors Early
Customer concentration, owner dependence, and key person risk all compress multiples. Start addressing these issues 2-3 years before a planned exit to maximize value.
Clean Up Your Financials
Review financials, accrued financials, or audited statements give buyers confidence. Messy books with lots of adjustments create uncertainty that depresses value.
Run a Competitive Process
Multiple interested buyers create competition that drives higher valuations. A single buyer knows they have leverage; multiple buyers have to compete.
Frequently Asked Questions
What valuation method do buyers typically use?
Most strategic and financial buyers use EBITDA multiples as their primary valuation method for established businesses. They'll often validate with a DCF analysis. The multiple applied depends on your industry, size, growth rate, and risk profile. Buyers may use different methods for different parts of the business.
What's a typical EBITDA multiple for a private company?
Private company EBITDA multiples typically range from 3x to 8x for most industries, with lower middle market companies ($5M-$50M revenue) often seeing 4x-6x. Multiples vary significantly by industry, growth rate, customer concentration, and recurring revenue. Strategic buyers may pay premiums for synergies.
Why is my company worth less than comparable public companies?
Private companies trade at a discount to public comparables due to lack of liquidity, less diversification, key person risk, and limited access to capital markets. This 'private company discount' or 'illiquidity discount' typically ranges from 20-35% depending on company size and characteristics.
What's the difference between enterprise value and equity value?
Enterprise value is the total value of the business (what a buyer pays for the whole company). Equity value is what the shareholders receive after paying off debt and adding back cash. Enterprise Value = Equity Value + Debt - Cash. When multiples are applied to EBITDA, they produce enterprise value.
How do buyers adjust EBITDA for valuation?
Buyers calculate 'adjusted EBITDA' by adding back non-recurring expenses, owner compensation above market rate, personal expenses run through the business, and one-time costs. They also normalize for unusual revenue or cost items. This adjusted figure becomes the basis for applying multiples.
When is asset-based valuation appropriate?
Asset-based valuation is used for asset-heavy businesses (real estate, manufacturing), holding companies, businesses being liquidated, or when the company isn't generating sufficient returns on its assets. It sets a floor value and is often used alongside other methods.
How does customer concentration affect valuation?
High customer concentration (one customer >20% of revenue, or top 5 customers >50%) significantly reduces valuation multiples. Buyers see it as risk that revenue could disappear. Companies with diversified customer bases command premium valuations compared to concentrated peers.
What discount rate is used for DCF valuation of private companies?
Private company discount rates typically range from 15-30%, significantly higher than public company rates due to additional risk factors. The rate reflects the required return an investor needs given the risk of investing in a private, less liquid business with less diversification.
Planning an Exit or Evaluating Your Options?
Eagle Rock CFO helps business owners understand and maximize their company's value. From adjusted EBITDA preparation to exit readiness assessments, we bring CFO-level M&A expertise to growing companies.
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