What it means
Three families of method dominate. Market-based approaches apply a multiple from comparable companies or transactions, income-based approaches discount expected future cash flows to a present value, and asset-based approaches total up what the business owns less what it owes.
Which method fits depends on the business. A profitable, stable services firm is usually valued on a multiple of earnings, a young company with large future cash flows on a discounted cash flow model, and a property or investment holding company on the value of its assets.
The most common practical method for private businesses is a multiple of EBITDA, meaning earnings before interest, tax, depreciation and amortisation. That measure is used because it approximates operating cash generation before financing and accounting choices, making two differently financed companies easier to compare.
A critical step is moving from enterprise value to equity value. The multiple produces the value of the business as a whole, and the seller receives that figure less net debt, which is why paying down borrowings before a sale directly increases the proceeds to shareholders.
Adjustments matter as much as the multiple itself. Normalising earnings for owner salaries above or below market rate, one-off legal costs or related-party rent can change the answer substantially, and a well-prepared seller documents each adjustment before the buyer's advisers find it.
Deal structure then decides how much of the valuation is real. Earn-outs, deferred consideration, retained equity and working capital adjustments all sit between the headline number and the cash a seller banks, so a lower price paid entirely at completion can beat a higher one paid over three uncertain years.
In practice
Real-world examples.
Example
Two founders splitting a marketing agency commission an independent valuation to settle a buyout. The valuer applies a multiple to normalised earnings after adjusting for one founder's below-market salary, and the adjusted figure becomes the basis for the settlement.
Example
A venture-backed software company raising a funding round is valued on a multiple of annual recurring revenue rather than profit, because it is deliberately loss-making while it grows. The negotiation centres on growth rate and customer retention rather than current earnings.
Example
A family business preparing for sale spends eighteen months reducing its dependence on the founder, documenting processes and repaying debt. Both the multiple achieved and the cash received at completion improve as a result.
Think of it
“Company valuation is figuring out what a business is worth-calculating its price.
Formula
Calculation
Enterprise value = EBITDA x Valuation multiple, and Equity value = Enterprise value - Net debt, where net debt is total debt less cash. A specialist engineering firm generates EBITDA of $5,000,000 and comparable transactions in its sector have completed at around 7 times EBITDA, giving an enterprise value of $5,000,000 x 7 = $35,000,000. The company has $9,000,000 of borrowings and $2,000,000 of cash, so net debt is $7,000,000 and equity value is $35,000,000 - $7,000,000 = $28,000,000, or $7.00 per share across 4,000,000 shares. At a more cautious 6 times multiple, enterprise value falls to $30,000,000 and equity value to $23,000,000, or $5.75 per share, which shows how much a single turn of multiple is worth.Case study
Seen in the real world.
Larkfield Dental Group is an illustrative, fictional chain of four practices whose owner planned to retire. Its reported EBITDA was $2,000,000, and at the sector benchmark of 6 times that implied an enterprise value of $12,000,000.
The owner's adviser normalised the earnings first. She had been paying herself $650,000 a year against a market rate of roughly $250,000 for the equivalent clinical and management role, so $400,000 was added back, lifting adjusted EBITDA to $2,400,000 and the implied enterprise value to $2,400,000 x 6 = $14,400,000, a difference of $2,400,000.
The buyer accepted the salary adjustment but challenged a second one relating to a lease with a related party. This fictional example illustrates the general pattern in private company sales: the multiple gets the headlines, while the real negotiation happens line by line over what the earnings figure should be.
Watch out
Common mistakes.
- Confusing enterprise value with what the seller receives. Debt is deducted and surplus cash added, so equity proceeds can differ dramatically from the headline valuation.
- Using a listed company multiple for a small private business. Private companies trade at a discount for illiquidity, key person risk and customer concentration, often a substantial one.
- Valuing on revenue when profit is the relevant driver. Revenue multiples suit high-growth subscription businesses, not a mature contractor whose margins define its worth.
Questions
People also ask.
Which valuation method is most accurate?
None is definitively accurate; sensible practice is to run two or three methods and treat the overlap as the defensible range.
What multiple should my business expect?
It depends on sector, size, growth and risk, with small owner-dependent businesses typically at the lower end and larger, diversified ones commanding more.
Does a valuation guarantee a sale price?
No, it informs the negotiation, and the final price depends on buyer appetite, competitive tension, deal structure and due diligence findings.
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