Business Valuation Basics: How Owners and Investors Arrive at a Number

At some point, someone will ask what your business is worth. Maybe it is an investor wanting a stake. Maybe it is a partner buyout. Maybe you are thinking about selling in a few years. Most owners do not know the answer, or they give a number with no basis behind it.

Valuation is not magic. There are a handful of methods that get used repeatedly, and understanding them puts you in a much stronger position in any negotiation.

Why Valuation Is Both Art and Math

Valuation methods produce a range, not a single precise number. Two reasonable people using the same method can arrive at different values depending on their assumptions. That is normal. What matters is understanding which method is being used, why, and what assumptions drive the number.

Investors and buyers will push for a lower value. Sellers and owners will push for a higher one. The negotiation happens in the assumptions, not just the headline number.

The Main Methods Used for Small Businesses

Multiple of Earnings

This is the most common method for small and mid-size businesses. You take a measure of earnings, typically EBITDA (earnings before interest, taxes, depreciation, and amortization), and multiply it by a number that reflects how attractive the business is to a buyer.

For a small Canadian business doing under five million in revenue, multiples typically range from two to five times EBITDA, though this varies significantly by industry, growth rate, customer concentration, and how dependent the business is on the owner personally. A business with ten clients where the owner does all the work commands a lower multiple than one with one hundred clients and a team that runs independently.

Before applying any multiple, the earnings figure usually gets adjusted. Owner compensation, one-time expenses, and personal items run through the business get added back to arrive at a normalized earnings number. This is called a recasting or normalization of earnings.

Revenue Multiple

Some businesses, especially early-stage ones or those with high growth rates and thin margins, are valued on a multiple of revenue rather than earnings. SaaS businesses are a common example. A business doing $500,000 in annual recurring revenue might be valued at two to four times revenue, regardless of current profitability, if the growth trajectory justifies it.

Revenue multiples are more common in venture and growth-stage financing. For most traditional small businesses, earnings multiples are the more relevant benchmark.

Asset-Based Valuation

For businesses where the assets are the value, such as real estate holding companies, certain manufacturers, or businesses being wound down, value is calculated from the balance sheet. You take the fair market value of all assets and subtract all liabilities. What is left is the net asset value.

Most service businesses are not valued this way because the real value is in the earnings stream and the customer relationships, not the furniture and computers.

Discounted Cash Flow

A discounted cash flow analysis projects the free cash flows the business will generate over several years and discounts them back to present value using a required rate of return. This method is theoretically rigorous but highly sensitive to assumptions. Small changes in the growth rate or discount rate produce very different values.

DCF is more common in larger transactions or when a sophisticated buyer is involved. For most small business sales and early-stage financing, it is used as a sanity check rather than the primary method.

What Owners Get Wrong

The most common mistake is anchoring on revenue. Owners frequently say their business is worth a multiple of revenue because they have heard that somewhere. But unless you are a high-growth tech company, buyers care about earnings, not revenue. A business with $2 million in revenue and $50,000 in profit is not worth two million dollars.

The second mistake is not normalizing the financials before the conversation. If owner compensation is artificially low or high, if personal expenses run through the business, or if there are one-time costs that inflated expenses last year, those need to be adjusted before any multiple is applied. A buyer will do this anyway during due diligence. Doing it first puts you in control of the narrative.

An Illustrative Example

Consider a business services firm doing $1.8 million in revenue. The income statement shows $120,000 in profit. But when you normalize the financials, the owner is paying themselves $80,000 less than market rate, and there was a one-time legal expense of $40,000 last year. Adjusted EBITDA is closer to $240,000. At a three-times multiple, that is a $720,000 business. At four times, $960,000. The multiple is where the negotiation happens, but the normalized earnings figure is the foundation.

Who Should Do Your Valuation

For a formal valuation, a Chartered Business Valuator (CBV) in Canada is the recognized credential. If you are doing a share sale with significant value, estate planning involving the business, or litigation, you want a CBV sign-off.

For a financing conversation or internal planning, a fractional CFO or M&A advisor can help you build a normalized earnings picture and benchmark multiples without the cost of a full valuation report. The goal is to know your number before someone else tells you theirs.

What to Do Before Any Valuation Conversation

1. Clean up your financials for the last three years. Remove personal expenses, normalize owner pay, and document any one-time items.
2. Calculate your EBITDA and normalized EBITDA. Know both numbers and the adjustments between them.
3. Research industry multiples. Your accountant, an M&A advisor, or a business broker can give you a realistic range for your sector.
4. Identify your business's risk factors. Customer concentration, owner dependency, lease terms, and key employee risks all affect where in the multiple range your business lands.
5. Decide whether you need a formal CBV report. For most early conversations, a working estimate is sufficient. For legal or tax purposes, you need the formal opinion.

Knowing your valuation range before a conversation gives you something most owners do not have: leverage. If you want to work through the numbers and figure out where your business stands, book a free call at peterxiacpa.com/book.

Next step: run your numbers through the free CFO scorecard.