What Goes Into a Business Valuation — From the Buyer's Perspective
Every business owner has a number in their head. The number they think their business is worth. The number they'd accept. The number they'd be thrilled with.
Here's the problem: that number almost never lines up with how a private equity firm actually values a business. And the gap between those two numbers is where millions of dollars get left on the table — or deals fall apart entirely.
As a PE investor who has been on the buy-side of more than 40 M&A processes, I want to walk you through exactly how we determine what a business is worth. Not the theoretical version — the real one.
It Starts With EBITDA — But Not the Way You Think
Every owner knows that valuation typically starts with EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). But what most owners don't realize is that your EBITDA and the buyer's EBITDA are almost never the same number.
The buyer will run a Quality of Earnings (QoE) analysis — essentially an independent audit of your financials. They'll strip out one-time events, normalize owner compensation, adjust for non-recurring revenue, and recategorize expenses. The number they arrive at is "adjusted EBITDA," and it's almost always lower than what the owner reported.
Common EBITDA Adjustments Buyers Make
- Owner compensation normalization — If you're paying yourself $100K but the market rate for your role is $250K, the buyer deducts the difference
- One-time revenue — That big project last year? If it won't repeat, it gets stripped out
- Related-party transactions — If you're leasing the building from yourself at below-market rates, the buyer adjusts to market rent
- Deferred maintenance — If you've been underinvesting in equipment or infrastructure, the buyer prices in catch-up costs
The Multiple: What Moves It Up or Down
Once they have the adjusted EBITDA, the buyer applies a multiple. For most lower middle market businesses ($5M–$50M revenue), multiples typically range from 3x to 7x EBITDA — a massive range. The difference between a 4x and a 6x multiple on $2M EBITDA is $4 million.
So what determines where you fall in that range? Six factors:
1. Revenue Predictability
Recurring revenue gets the highest multiples. Contractual revenue (subscriptions, maintenance agreements, retainers) is worth more than project-based revenue, which is worth more than one-time transactional revenue. The more predictable your cash flow, the more a buyer will pay.
2. Customer Concentration
If your top customer is more than 15% of revenue, expect a discount. If they're more than 30%, expect a significant discount — or expect the buyer to structure the deal with earnouts tied to customer retention. Diversified revenue = higher multiples.
3. Owner Dependence
Can the business run without you? If yes, you'll trade at the higher end. If no — if you are the sales engine, the primary relationship, the only decision-maker — you'll trade at the low end. This is the single most common reason for multiple compression.
4. Growth Trajectory
Flat or declining businesses trade at low multiples. Growing businesses trade higher. But the growth has to be proven — not projected. Buyers will look at your trailing 12–24 months and weight recent performance heavily. A growth story without evidence is just a story.
5. Industry and Market Position
Some industries command higher multiples (SaaS, healthcare, specialized manufacturing). Some command lower (commoditized services, retail). Within any industry, the businesses with defensible competitive advantages — proprietary technology, exclusive contracts, regulatory moats — trade at premiums.
6. Quality of the Management Team
Does the business have a real management team, or is it the owner plus a group of employees who follow instructions? Businesses with strong #2s and #3s — people who can run departments independently — are worth significantly more.
Beyond the Multiple: Deal Structure Matters More Than Price
Here's something most owners don't realize until it's too late: the headline price is almost never what you actually receive. Deal structure determines how much cash you get at close versus how much is tied up in earnouts, rollover equity, seller notes, and working capital adjustments.
A $20M offer where $8M is in an earnout you may never collect is worse than a $16M offer that's all cash at close. The structure is the deal — the price is just the headline.
"Valuation is not what someone offers you. It's what you walk away with after the deal closes."
Want to Know What Your Business Is Actually Worth?
Not the number you hope for — the number a buyer would actually pay, based on how PE firms really evaluate deals. The first conversation is free.
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