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How I Think About Valuing a Small Business
- Jose Alvarez, CFP®, MBA
- Jan 4
- 9 min read
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With how long the internet has been around, you'd think all of the finance questions one could ask would have already been asked. While that might be pretty close true, it's always easier to ask and answer again than it is to search through the endless maze of information.
Working with business owners is something I really enjoy... because I am one myself. I know how it feels to make the decisions and have the weight of the outcomes on your shoulders. So, when business owners ask me questions, even if it seems like a basic question...
As the saying goes:
I've heard this question 100x... but it's the first time you've asked it.
The question I found for this topic was simple:
A small business owner laid out a few high-level numbers for a home services business that focuses on HVAC and electrical. The business has roughly $2.5 million in revenue, about $600,000 of EBITDA, he pays himself $500,000 of income and he wondered what a business like that might be worth since he's burnt out and ready to sell.
There wasn’t a lot of detail, and that’s okay. When I weigh in on these social media questions, I don't do so in a way that's intended to be personalized advice. I do this to express how I think about things and the stuff I look at when I make decisions and recommendations for my clients, not what people I have never even spoken to should do.
So, let’s talk about it that way.
Start with the Type of Business, Not the Multiple
Before I even look at the numbers, I want to understand what kind of business we’re talking about.
Industry
Ownership
Services/Products Sold
Niches or Specializations
Knowing the type of business that we're working on sets the stage for how we might approach the valuation, the sale, or the transition to the owner's next generation - whatever goal they had in mind.
In the case of this person on Reddit, it appears to be a small, service-based business - a home services business that focuses on HVAC and electrical and, likely, is single-owner/operator due to the level of income they say they produce for their take-home pay.
Why does that matter? Because service businesses, whether they’re home services, professional services, or specialty trades, tend to derive most of their value from earnings, not physical assets like equipment or machinery.
Yes, there may be tools. Yes, there might be vehicles. There could even be some inventory sitting around but for most small service businesses, especially those run by an owner, possibly with a small team, the income statement is where the real value is, not what's shown in the balance sheet (although that can matter, too).
Why the EBITDA Number Jumps Out
On the surface, $600,000 of EBITDA on $2.5 million of revenue isn’t bad. But, for me, it does raise questions about how the business is being run and the decisions being made.
In many service-based businesses, margins can be higher when pricing is tight, labor is efficient, and overhead is controlled. When EBITDA feels compressed, it’s often not because the business is broken... it's usually because the business hasn’t been normalized.
That’s an important difference.
Let's break down a list of some of the most common items that throw off what might be an expected EBITDA:
Owner compensation being way above industry norms - at $500,000 this post explained, I'd say that's pretty well above industry norms by like... $200,000 for this type of business with revenues under $4M.
Discretionary expenses that don't fit typical expenses for the size, structure, or specialization of the business
Personal spending running through the business instead of being paid the owner
So, what might this look like? Let's keep it basic and consider just a multiple of EBITDA.
This first table assumes no adjustments. This was a quick sale intended to let the owner move on with their life:
Metric | Amount |
Revenue | $2,500,000 |
Reported EBITDA | $600,000 |
Multiple | 4x |
Enterprise Value | $2,400,000 |
For this next table, let's assume the owner did a little bit of cleaning up before the sale so we were able to make some adjustments to the EBITDA. If we assume $200,000 of addbacks for excess owner's compensation, $45,000 for auto/travel expenses, plus a $15,000 one-time legal expense, suddenly we have an $860,000 adjusted EBITDA.
Here's what that looks like:
Metric | Value |
Revenue | $2,500,000 |
Reported EBITDA | $600,000 |
Addbacks | +$260,000 |
Adjusted EBITDA | $860,000 |
Multiple | 4x |
Enterprise Value | $3,440,000 |
That's a $1 million dollar difference on $260,000 worth of addbacks discovered.
As we can see, taking some time to plan this out and really dive into the numbers can have a dramatic impact on the outcome. Sure, this business owner may have wanted a quick sale but, if shown the impact this decision may have on the outcome, would they still make that choice? Maybe... depending on the reason for the exit. Still, these numbers and adjustments carry weight.
Not only do these expenses all reduce reported EBITDA, but they may also not be reported correctly for tax purposes. For example, if you buy a vehicle for the business but you use it for personal reasons, the mileage for both must be tracked independently. If you buy a personal vehicle but pay directly from the business, it looks like a deductible business expense rather than a personal vehicle.
Buyers expect this to some degree... they'll know that small business owners tend to comingle assets, income, and expenses (the IRS knows it, too), but they don’t ignore it. They require it to be identified, documented, and adjusted. Which leads directly into the first real decision a business owner has to make.
Are You Exiting Quickly, or are You Exiting Strategically?
This is where most conversations about selling a business go into fairytale-land for small business owners. The best way to sell is both fast and have the absolutely perfect buyer fit... obviously... but I don't live in a unicorn fantasy land where we can rely on that outcome for most people.
A quick exit and a strategic exit are two very different paths.
A quick exit prioritizes speed and certainty. You accept the business largely as-is, you probably don’t invest much time cleaning things up or making them buyer-ready, and you understand that you may be leaving some value on the table. In these cases, the exit is the most important thing and we're willing to sacrifice some value for the quick and easy transition. Nothing wrong with that... we just have to know what sport we're playing here.
A strategic exit is different. It assumes you’re willing to make changes before selling - we're looking to improve the business in a material way that can show potential suitors that we're serious about this business and what to exchange value that goes beyond what the line items in the Financial Statements say.
That might mean formalizing processes, cleaning up expenses, tightening documentation, and/or making sure licenses and compliance items are clean and current.
It also means being thoughtful about buyers.
Not every buyer wants the same thing. Some buyers want the entire operation. Others only want pieces of it. If a buyer’s plan involves cutting out a core function that actually drives earnings, that misalignment can hurt value, even if the headline number looks attractive.
Once you know how you want to exit, the next question becomes unavoidable.
Are You Doing This by Yourself, or are You Building a Team?
For a business likely selling under $5 million, the team doesn’t need to be huge but going about it alone typically isn't the best option.
Why? Who knows the business better than the owner?
Simple... because the owner knows the business... the CPA knows the tax impact and ideas on how to optimize it pre- and post-sale; the attorney knows how to advise on the best sale method like stock or asset and possibly negotiate on your behalf; and your wealth manager knows how all of these pieces fit together to help keep your money bringing life-long value after the sale.
So, at a minimum, this is what I like to see:
A strong CPA who works with business owners
An M&A attorney
A financial planner that understands how to help you maximize your life after you've moved on
Selling a business isn’t just about price. It’s about structure, timing, taxes, and what comes next.
Valuation is Rarely “2x or 3x EBITDA”
One of the most common misconceptions I see is the idea that businesses sell for a flat multiple of earnings.
Sometimes they do... but often they don't and if you go this route, likely you're looking for the quick exit we talked about earlier and chances are high you're leaving value on the table.
Multiples depend on industry, buyer intent, size, growth trends, customer concentration, owner dependence, seller negotiables, and how transferable the business actually is. They also depend on whether assets materially contribute to earnings or simply support operations.
For example, in the RIA world, it's not uncommon for an advisory practice with no formal structures, teams, or growth plans in place that are nearly entirely dependent on the founder to sell for 3x-4x multiples of earnings. But when we account for private equity sales, earn-out clauses, fit with the buying firm, bonuses, etc., those multiples can be 10x-15x.
In this situation, if your assumption was 3x-4x so you accepted it when you could have gotten 7x-8x (with some strings attached), you might kick yourself for that later.
And then there’s adjusted EBITDA.
Cleaning Up Commingled Expenses Can Change the Story
Small business owners commingle expenses all the time. Business vehicles used personally... personal vehicles paid through the business... discretionary travel... family members questionably on payroll.
None of this is unusual; in fact, it's so commonplace that suitors expect that, to some degree, adjustments will need to be made - keep in mind that it that's doesn't mean it's always okay or on the up-and-up with the IRS. But when it comes to preparing for the sale, it does distort the numbers in a not-in-your-favor kind of way by reducing EBITDA.
Even though this may be happening, it should be found, documented, labeled clearly, and then added back in to arrive at Adjusted EBITDA. You may have made some "financially creative" decisions with the business, but the goal isn’t to hide that. The goal is to normalize it so a buyer can see what the business would produce if it were run cleanly. That adjustment alone can materially change perceived value.
Historical Financials Need Context, especially post-COVID
Buyers often want three to five years of financials for their due diligence prior to making an offer or accepting your valuation. That sounds reasonable until you remember how distorted the last several years have been.
COVID suppressed earnings for some businesses and inflated them for others. Government programs might have thrown you way off positively and possibly helped financially weak business continue to survive. Ultimately, 2020 to 2023 may have caused some years to look artificially strong while others look unfairly weak. We need to account for that, and we need to frame the valuation around these facts for a suitor.
Caveat, we're coming out of this distortion so weak businesses that were propped up by government programs are running out of time to use that excuse.
Understanding those patterns, and explaining them clearly, is critical. Raw numbers without context rarely tell the full story and can, again, work against you.
From There, Process Takes Over
Once value is understood, the rest becomes procedural.
Were you approached by a buyer, or are you going to market intentionally? Are you targeting a specific type of buyer, or opening it up more broadly? Are you prepared for a letter of intent, exclusivity, and negotiation?
None of this is mysterious, but it is sequential and can cause some anxiety, impatience, and fear. Skipping steps or rushing decisions usually costs leverage.
The Bigger Takeaway
Questions like the one I saw on Reddit are good questions. Everyone's exit process is different and asking the question can bring new and different ideas.
Valuing a small business isn’t about guessing a multiple. It’s about understanding how earnings are generated, how clean the numbers are, how transferable the operation is, and how intentional the exit plan has been.
The owners who get the best outcomes don’t stumble into a sale. They prepare for one. A good rule of thumb is:
Along your timeline, consider at what point you're about 5 years or so out from what you might call your "retirement" or, simply, your transition to the next season of life. This time period opens the door to a lot of options for transitioning out, someone transitioning in, and financial strategies that can help the exit be tax efficient, easier, and more easily digestible on the backend.
Time buys us confidence.
If you’re reading this because you’re thinking about selling your business, expanding it, or even just trying to understand what it’s actually worth, this is usually the point where an outside perspective helps. Not to rush a decision, but to make sure the decisions you are making line up with where you want to go.
These transitions don’t happen overnight, and the earlier you start thinking through the numbers, the structure, and the strategy, the more options you tend to have.
If you want to talk through what a sale, an expansion, or even a “not yet, but someday” plan might look like for your business, feel free to reach out. I'd love to have a conversation about you, your business, your family, and your future.
Jose Alvarez, CFP®, MBA
Financial Advisor
Founder
Harvest Horizon Wealth Strategies
The information presented in this blog is the opinion of the author and does not reflect the views of any other person or entity unless specified. The author may hold positions in any securities discussed in this blog. The information provided is believed to be reliable and obtained from reliable sources, but no liability is accepted for inaccuracies. This blog should not be interpreted as a full analysis of any particular subject including the subject discussed. Images included in this blog may be created by artificial intelligence. If so, resemblance to any existing persons, past or present, is purely coincidental. The information provided is for informational, entertainment, and educational purposes and should not be construed as advice. Advisory services are offered through Harvest Horizon Wealth Strategies LLC, an investment adviser registered with the state of Wisconsin.
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