How to value a business you want to buy: the buyer's lens
Short answer
As a buyer, start with three questions rather than a formula. What are the verified earnings? What price can those earnings carry after paying you and servicing debt (for SBA loans, at 1.25 coverage or better)? And what return does your cash need for the risk you're taking? The most you should pay is the lowest of what the market supports, what financing allows and what your required return justifies.
For a formal number, credentialed appraisers do valuations; in SBA deals the lender orders one. OKtoBuy's Deal Check doesn't give a value or price for your deal; the optional Value estimate is an estimate, not an appraisal.
Sellers think about value as what the business is worth. Buyers have to think about it as what they can pay and still be OK. Those are different questions, and the buyer's version has three parts.
The three ceilings
1. What the market and a valuation support
Prices for similar businesses, expressed as multiples of earnings, adjusted for this business's risks. Formal valuations do this properly; see how small business valuation works.
2. What financing allows
Lenders size debt from verified earnings. If verified SDE minus your salary and a capex reserve covers the payments at 1.25 or better, the price is financeable. If not, it isn't, whatever the market says. Test it with the DSCR calculator.
3. What your return requires
Your cash and your time are both at risk. After paying yourself a fair salary for the work, what's left should give your equity a return you'd accept for this level of risk. If a price only works with you working for free, it doesn't work.
Worked example: the three ceilings on one deal
Illustrative example, not a valuation or a recommendation
A business has verified SDE of $250,000. You need $85,000 a year to live on, and set aside $15,000 for equipment, leaving $150,000 for debt. Financing ceiling: at 1.25 coverage, debt service can be up to $150,000 ÷ 1.25 = $120,000 a year. At an example 10.5% over 10 years, about $16,200 a year services each $100,000 borrowed, so $120,000 supports roughly $740,000 of debt. With 10% equity, that's a project of about $820,000. Return ceiling: if you'd put in $82,000 and want at least a 20% cash return on it after your salary and debt, you need $16,400 a year left after debt: at $120,000 of debt service that leaves $30,000, which passes. Valuation ceiling: the lender's valuation, which you don't control. If it comes in at $700,000, the debt can't exceed $700,000, and anything you pay above it has to be equity. The lowest of the three is your real limit.
Common buyer mistakes in pricing
- Starting from the asking price and negotiating down, instead of building a number from verified earnings.
- Applying an industry multiple to unverified SDE.
- Forgetting what's not included: inventory, working capital, equipment replacement.
- Paying for growth the seller never achieved.
- Ignoring your own salary when you calculate the return.
- Assuming the lender's valuation will match the price. Make it a contingency.
Start with verified earnings
All three ceilings depend on earnings. If the seller's SDE includes add-backs that don't hold up, every ceiling drops together. That's why the first job is verifying earnings, not debating multiples. Use the SDE calculator and the add-backs guide.
Questions to answer before you name a price
- What are the verified earnings, after rating every add-back?
- What salary do I need, and what will the business need for equipment each year?
- How much debt can the remaining cash flow carry at 1.25 coverage or better?
- What equity can I put in, and what reserve will I keep?
- What return do I need on my equity and my guarantee, after paying myself?
- What risks (concentration, owner dependence, lease) should push my number down?
Answering these gives you a price you can defend with evidence, which is more persuasive to a seller than a counteroffer alone.
When to get a formal valuation
- SBA deals: the lender orders one; you can't substitute your own.
- Large non-SBA deals, partner buyouts and disputes: consider hiring a credentialed appraiser.
- Any deal where the asking price seems far from what earnings support.
Valuing a business for sale: why the asking price isn't the value
An asking price is the seller's opening position, usually set by a broker as a multiple of the seller's own SDE figure. It often sits above what a buyer's verified earnings and an independent valuation support, because the SDE includes optimistic add-backs and the multiple reflects the seller's hopes.
For SBA-financed deals, the lender's independent valuation must support the price; anything above it must be paid with extra equity, and total debt can't exceed it. That's often where asking prices meet reality.
The asking price is a number someone chose. It may be well reasoned, or it may be the seller's retirement plan with a multiple attached. Treat it as a claim to test, not a value to accept.
How an asking price is usually built
Why asking prices run high
- The SDE includes every add-back the seller could think of. Lenders will remove the ones without support.
- The multiple reflects the best comparable, not this business's specific risks.
- Room to negotiate is often built in.
- Inventory, working capital and equipment may be on top of the headline price.
What brings it back to earth
- Your earnings check. Rebuild SDE from returns and bank statements. See SDE.
- Your financing test. Can verified earnings cover the debt at 1.25 or better? Try the DSCR calculator.
- The lender's valuation in SBA deals: price above it must be equity; debt can't exceed it. See SBA business valuation.
Illustrative example, not a real deal
A business is listed at $900,000 on seller SDE of $300,000. Your check finds $50,000 of unsupported add-backs. The lender's valuation later comes in at $760,000. At $900,000, the buyer would need $140,000 of equity above the normal minimum just to close the gap. Most buyers renegotiate instead, using the documented earnings as the reason.
When you're ready to respond to an asking price, see how to make an offer on a business.
What you are buying, line by line
A price only means something once you know what it includes. Before comparing any number with another deal, write down which of these are in it:
| Item | Usually included? | Why it matters |
|---|---|---|
| Equipment, fixtures, vehicles | Yes, in most asset deals | Check age and condition; replacement is your cost |
| Inventory | Often extra, counted at closing | Can add a large amount on top of the headline price |
| Cash and receivables | Usually kept by the seller | You will need your own working capital |
| Payables and accrued wages | Usually paid by the seller | Confirm in the purchase agreement |
| Customer deposits, gift cards | Liabilities that come with the customers | Ask for a credit at closing |
| Real estate | Separate, if offered at all | Different loan terms and a separate appraisal |
| Non-compete and transition | Usually part of the price | Affects how the price is allocated for tax |
Two listings quoting the same price can be very different deals once inventory and working capital are counted. Compare them on the same basis or not at all.
Frequently asked questions
How do I know if an asking price is fair?
Compare it with what verified earnings can support: debt coverage at the financing you can get, a reasonable salary for you, a capex reserve, and a return on your cash. A formal valuation from a credentialed appraiser gives an independent view.
Should I rely on the broker's valuation?
No. Brokers are paid by the seller. For SBA deals, the lender gets its own valuation (from a credentialed Qualified Source, or internally for 7(a) Small and SBA Express loans at a business purchase price of $350,000 or less), and you can't use one prepared for the buyer or seller.
What return should I expect on a small business?
It depends on the risk and your alternatives. Small businesses are riskier than most investments, so buyers usually expect a higher return than they could get elsewhere. Work out your own number and test the price against it.
Does OKtoBuy tell me what to pay?
No. OKtoBuy checks the earnings and tells you what an SBA lender will look at. Price and value are for you, your advisers and a credentialed appraiser.
How do brokers set asking prices?
Usually by applying a multiple to the seller's SDE, informed by comparable sales and the seller's expectations. Brokers are paid by the seller and often price to leave room to negotiate.
Do businesses sell for their asking price?
Many sell below it, after diligence narrows the earnings and buyers negotiate. Listings show asking prices, which are not evidence of what buyers paid.
Sources
- SBA SOP 50 10 8.1, Appendix 15 (valuation by Qualified Source; DSC requirements)
- SBA: Buy an existing business or franchise
Related guides
General information, not legal, tax, financial or investment advice. Rules and lender practices change; check the linked sources and talk to your attorney, CPA and lender about your deal. Examples with named numbers are illustrations, not real businesses. OKtoBuy's Deal Check does not value businesses or give price opinions.