Your business is worth its true, documented earnings multiplied by a number that measures how risky and how transferable those earnings are. Every word in that sentence gets negotiated: the earnings through add-backs, the multiple through arguments about risk, and even the headline price is not the check you take home. This article walks through all three fights, in the order a buyer will pick them.
The Formula: Earnings Times a Multiple
Nearly every profitable small business that changes hands is priced the same way: a normalized earnings figure times an agreed multiple. I covered the basic methods in my guide to selling your LLC in Illinois; this article goes deeper into how each half of the formula gets fought over.
Notice what the formula does. Every dollar you can legitimately add to earnings is worth several dollars of price, and every step the multiple moves is worth a multiple of your entire earnings. On a business earning $200,000, moving the multiple from 2.5 to 3 adds $100,000; moving documented earnings up $30,000 at a multiple of 3 adds $90,000. (Those figures, like every number here, are invented round numbers illustrating the arithmetic, not market data.) The negotiation is never about "the price." It is about the two inputs, and a professional buyer negotiates both while you are still thinking about one.
SDE vs. EBITDA: Which Earnings Number Applies to You
The first fight is which earnings definition you are even using, because the same business produces two very different numbers.
Seller's Discretionary Earnings (SDE) is the total financial benefit one working owner pulls out of the business: net profit, plus the owner's salary and benefits, plus personal expenses run through the company, plus true one-time costs. SDE is the main-street standard, used when the buyer is an individual who will step into your chair and work the business full time. That buyer is really buying a job plus a return: the business has to pay them a fair salary and a satisfactory return on their investment, or they are better off staying employed.
EBITDA is earnings before interest, taxes, depreciation, and amortization. It applies to larger businesses with a management layer, bought by companies or funds rather than individuals. Here is the trap: EBITDA is calculated after charging a market-rate salary for whoever will manage the business, so if you run the company yourself, a buyer subtracts the cost of your replacement first. That is why the same business always shows a bigger SDE than EBITDA, and why comparing your SDE against an EBITDA multiple you read about online overstates your value badly.
- Owner works in the business daily
- Buyer is an individual replacing you
- Owner's full compensation added back
- Price reflects buying a job plus a return
- Management team runs day to day
- Buyer is a company or fund
- Market salary for a manager subtracted
- Multiples run higher, but on a smaller number
EBITDA multiples run higher, but they apply to the smaller, salary-adjusted number; applying one to your SDE double-counts. Moving from the SDE world into the EBITDA world is a real strategy, but it means building management depth before you sell, the whole subject of my exit-ready LLC guide.
The Add-Back War
Normalizing earnings means restating your books to show what the business truly generates for its owner; the individual adjustments are called add-backs. This is the highest-leverage pre-sale work a seller can do, and also where sellers lose credibility fastest. The classic categories have not changed in forty years:
Owner compensation. Whatever you pay yourself, above or below market, gets normalized. This cuts both ways: the owner who underpays herself must show what a replacement really costs.
Personal expenses through the business. The family cell phones, the truck that is really yours, the trip that was mostly vacation. This is the most common legitimate add-back, and the first place the buyer's accountant looks.
Rent normalization. If you own the building and charge no rent, your earnings are inflated by a cost every buyer will bear; above-market rent to yourself works in reverse. Either way, a fair market occupancy charge goes in.
True one-time items. The flood, the lawsuit, the website rebuild. "One-time" is the most abused phrase in small-business accounting, and buyers know it.
A worked illustration, with invented numbers: an HVAC company shows $80,000 in net profit. The owner drew a $95,000 salary, ran $12,000 of personal vehicle and phone costs through the company, and paid $18,000 defending a lawsuit, now fully resolved. SDE is the sum: $205,000. At any multiple, the gap between pricing off $80,000 and pricing off $205,000 is the whole deal. The add-back schedule, not the asking price, is the real opening argument.
The clean-up also takes time to season: because buyers average multiple years, this year's changes only fully count once they have a track record. If a sale is even on your five-year horizon, start now.
The Multiple Is an Argument, Not a Market Fact
Owners talk about "the multiple" as if it were posted somewhere, like a stock price. It is not. A multiple is a compressed argument about the future: whether the earnings will continue, how fast they might grow, how much cash the business consumes to keep running, and, above all, whether the earnings survive the handover to a stranger.
Flip the multiple upside down to see this. A buyer paying 3 times earnings needs the business to pay for itself in about three years, roughly a 33 percent annual return for the risk; a buyer paying 5 times is accepting a 20 percent return, meaning they see the earnings as safer. A low multiple is not "the market." It is an assertion that your earnings are risky, and every element of that assertion can be contested.
That is why "the industry trades at X" should never end the conversation. Buyers quote comparables when comparables are low and pivot to business-specific arguments when comparables are high. Two businesses with identical profits can warrant different multiples: rising earnings beat flat earnings, a business that needs constant equipment replacement is worth fewer turns than one that runs on a laptop, and two hundred customers beat three. The seller who can explain why their earnings deserve a higher multiple, with documents, is negotiating; the seller who repeats a number is haggling inside the buyer's frame.
Why "A Guy Told Me Businesses Sell for Two Times Revenue" Fails
Owners regularly tell me their business is worth some multiple of revenue because a broker, a competitor, or a guy at a trade show said so. Revenue rules of thumb fail because revenue is not what a buyer keeps. Two contractors each billing $1,000,000 can take home wildly different profits, and pricing both at "two times revenue" values them identically, which no buyer who can read a profit and loss statement will ever do.
The deeper problem is that industry rules of thumb are set by nobody in particular, on factors nobody can examine. A well-informed buyer will not pay a price defined only by a formula, and a seller who anchors on one has no answer when the buyer's accountant starts asking real questions. Rules of thumb are a sanity check at best; the earnings analysis wins.
Unsolicited buyers count on you not knowing your number. If one has approached you, read my guide on what to do when someone wants to buy your business before you respond.
What Actually Moves the Multiple Up
If the multiple is a risk argument, raising it means removing risks before a buyer can price them. Four factors do most of the work at main-street scale:
Transferability is the master variable: if the earnings stream is really your personal relationships and your license, a buyer is right to discount it, which is why owner-dependent deals carry long transitions and tight non-competes. Customer concentration gets priced most brutally because the buyer cannot fix it: if one customer is 40 percent of revenue, the business gets priced as it would look the day that customer leaves. Clean books earn their multiple twice, since verified earnings support the price while sloppy records license the buyer's accountant to assume the worst. And management depth is what eventually moves a business from SDE pricing to EBITDA pricing.
All four factors are buildable, and none can be built during a sale process. They are one-to-three-year projects, which is why valuation work belongs at the start of your LLC ownership life cycle, not the end.
The Headline Price Is Not What You Pocket
Buyers quote prices as if the business had no debt and no excess cash, what deal lawyers call enterprise value. Sellers hear that number and mentally deposit it. The gap is where deals turn bitter, so here is the bridge, with invented round numbers.
| Illustration Only (Invented Figures) | Amount |
|---|---|
| Headline purchase price | $900,000 |
| Pay off business loan and equipment financing | ($140,000) |
| Escrow / holdback until releases issue | ($90,000) |
| Broker commission and professional fees | ($75,000) |
| Federal and state taxes on the gain | (varies with allocation and structure) |
| Wired at closing, before taxes | $595,000 |
Three mechanisms drive the erosion. First, debt comes off the top: the headline price assumes the buyer gets the business unencumbered, so your SBA loan, equipment notes, and lines of credit get paid from your proceeds. Second, working capital: in larger deals the parties set a normal level of receivables and inventory, called a peg, and the price adjusts based on what is actually there at closing; in small Illinois deals it shows up as who keeps the receivables, whether cash is included, and the bulk sale holdback held in escrow until the state issues tax releases. Third, taxes and fees, where the purchase price allocation can swing your tax bill substantially; I cover that mechanism in the selling guide.
These definitional points are pricing terms wearing legal-boilerplate costumes. Every item the buyer's lawyer classifies as "debt-like" moves the price dollar for dollar. Model every proposed definition against your actual balance sheet, and convert every formula into a dollar figure before you sign. "We will true up working capital at closing" sounds administrative until it costs you $40,000.
Want a Second Opinion on a Number?
Whether you have an offer in hand or you are just planning ahead, I will walk through the earnings math, the add-backs, and the structure with you before you commit to anything.
Your Price, My Terms
There is an old deal-table line: "You can name the price if I can name the terms." A buyer who cannot justify your number in cash can agree to it on paper and claw the risk back through structure.
Suppose you insist on $1,000,000 (invented, as before). Buyer A offers $850,000 cash at closing. Buyer B offers your full $1,000,000: $500,000 cash, a $250,000 promissory note over five years, and $250,000 contingent on revenue targets you will no longer control. Buyer B "paid your price," yet depending on how the note is secured and the targets are defined, Buyer A may be the better deal. The contingent piece is an earnout; the definitional games buyers play with earnout metrics are the subject of my earnouts guide. The note is seller financing: a useful tool, but priced as what it is, a loan from you to a stranger secured by a business you just handed over.
Structured deals are not bad; every term just has a cash value you must compute before agreeing. These trades first appear in the letter of intent, precisely when sellers have the most leverage and use the least of it. The valuation fight and the terms fight are the same fight, and a seller who wins the multiple argument, then gives it back through an unsecured note and a loose earnout, has won nothing.
Frequently Asked Questions
SDE (Seller's Discretionary Earnings) is net profit plus everything one working owner takes out of the business: salary, benefits, personal expenses, and one-time costs. It is the main-street standard when an individual buyer will replace the owner. EBITDA, used for larger businesses with management teams, is earnings before interest, taxes, depreciation, and amortization, calculated after charging a market salary for management. Never apply an EBITDA multiple to an SDE number.
An add-back restates your books to show the true earning power of the business: the owner's salary, personal expenses run through the company, above or below-market rent paid to yourself, and genuine one-time costs. Add-backs get multiplied by the deal multiple, so each documented dollar is worth several dollars of price. Buyers reverse any add-back they can recast as a recurring cost, so attach evidence to each one.
Almost never for main-street businesses. Revenue ignores profitability: two businesses with identical sales can have completely different earnings, and buyers pay for earnings. Rules of thumb are set by nobody in particular on factors nobody can examine, and a well-informed buyer will not pay a price supported only by a formula. Treat them as a sanity check at most.
No. The headline price is typically quoted as if the business had no debt, so your loans get paid off from the proceeds. Part often sits in escrow until Illinois tax releases issue, part may be deferred through a seller note or earnout, and broker fees and taxes come out of what remains. Compare offers on what reaches your bank account, not on the headline.
Not always a formal appraisal, but you need a defensible earnings analysis before you talk to any buyer, because whoever names a supported number first controls the frame. If you commission an appraisal, pay a flat fee: one priced as a percentage of value or contingent on closing loses its credibility as a negotiating tool. For most main-street sellers, a documented SDE calculation does more work than an expensive report.