Most business owners have a number in their head. It's usually based on something — years of revenue, a rough multiple they heard at an industry event, what a competitor supposedly sold for. The number feels real because it's grounded in real things: the work you've put in, the employees you've kept, the customers who've trusted you for decades.

Buyers have a different number. And it's calculated differently.

The gap between those two numbers is where most exits go wrong — not because sellers are unreasonable, but because they're using a different formula. This article explains how buyers actually arrive at their number, so you can evaluate yours before you're sitting across the table from one.

This is the most important reframe in any valuation conversation, and it changes everything that follows.

When a buyer evaluates your business, they're not paying for the 25 years you've spent building it. They're not paying for your client relationships, your reputation, or your employees' institutional knowledge — at least not directly. They're paying for the cash flow they expect the business to generate after they own it, without you in it.

That distinction matters because it immediately surfaces the question buyers are always asking: What does this business look like when the current owner leaves?

If the answer is "about the same," that's a business with real enterprise value. If the answer is "it depends on who the owner takes with them when he goes," that's a different conversation — and a lower number. More on that in a moment.

Before a buyer applies any multiple, they need to establish a baseline for what the business actually earns. There are two primary metrics for this, and which one applies depends largely on the size of your business.

Seller's Discretionary Earnings (SDE) is the standard for smaller owner-operated businesses — typically those generating under $1M–$2M in annual earnings. SDE starts with net income and adds back the owner's compensation, personal expenses run through the business, depreciation, amortization, interest, and any other one-time or non-recurring items. The logic: a buyer wants to see the true economic benefit of owning this business, which includes what the current owner is extracting from it.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the standard for larger businesses — typically those with $1M+ in annual earnings where a professional management team is already in place. Because these businesses don't depend on the owner's personal income to function, the calculation is simpler and focuses on operating performance rather than owner benefit.

A word on add-backs: both metrics involve "adding back" certain expenses to arrive at a normalized earnings figure. Add-backs are legitimate — personal vehicle expenses, owner life insurance, one-time legal costs. But buyers scrutinize them carefully. Excessive add-backs, or ones that are difficult to document, create skepticism. A high add-back number with weak support doesn't increase your valuation — it raises questions about the integrity of your financials.

Once a buyer has a clean earnings number, they apply a multiple to it. That multiple is where most of the value creation — and value destruction — happens.

Multiples aren't arbitrary. They reflect what buyers in your industry, at your business size, have historically paid for businesses with your characteristics. Smaller businesses typically trade at lower multiples than larger ones, because size itself is a risk factor — fewer customers, less management depth, more exposure to any single disruption. Larger businesses with diversified revenue and professional management command higher multiples because the cash flow is more predictable and the transition risk is lower.

What buyers are actually doing when they set a multiple is pricing the certainty of future cash flow. A business where the cash flow is highly predictable, well-documented, and not dependent on any single person or customer is worth more — not because it earns more, but because the buyer can underwrite it with confidence.

The factors that push multiples up:

The factors that compress multiples — or kill deals entirely:

Even after a buyer lands on a valuation, they have one more lever: deal structure.

Not every sale is a clean all-cash transaction at close. Buyers frequently propose earnouts (a portion of the purchase price paid contingent on future performance), seller financing (you carry a note), or retention requirements (you stay involved for a defined transition period). These aren't always bad for sellers — but they're always a signal.

When a buyer proposes a heavy earnout or a significant seller note, it usually means one of two things: either they couldn't secure full financing, or they have lingering uncertainty about whether the business will perform as represented after the transition. Deal structure is how buyers manage risk they can't fully price into the multiple.

Understanding this going in changes how you negotiate. An earnout tied to metrics you control is different from one tied to metrics you don't. Seller financing at a reasonable rate may be worth accepting to close a deal — or it may be a sign the buyer needs you to absorb risk they can't. What Buyers Are Actually Looking For covers the due diligence factors that typically drive these conversations.

Here's the practical takeaway: knowing the formula gives you a roadmap.

You can't control the market or what multiples are doing in your industry right now. But you can control a significant number of the factors that determine where within the multiple range your business lands. Owner dependency, customer concentration, documentation quality, financial clarity — these are all addressable before you go to market. They're just not addressable once you're in a process and an offer is already on the table.

The most useful thing most owners can do before going to market is get a professional valuation — not a broker's estimate designed to win your listing, but an honest, methodology-based assessment of where your business stands today and what a buyer would likely pay. That number won't always be the number in your head. But it's the number that matters.

Why Your Business Might Be Worth Less Than You Think walks through the specific factors that most commonly discount value below owner expectations — and what to do about each on