How private equity actually values your business

Here is the whole formula, up front: adjusted earnings, times a multiple, equals the value of your business. That is it. Most private equity valuation discussions begin with those two inputs, then adjust for deal structure, debt, working capital, and diligence findings. Adjusted earnings is what the business really makes for its owner once the books are cleaned up. The multiple is how many years of those earnings a buyer will pay today, and it goes up or down based on how safe and how promising your business looks to them.

If you want to apply that formula to the revenue, profit, and owner pay you already know, get a directional value range for your business. No financial uploads are needed, and no sales call is required.

So a shop with 500 grand in adjusted earnings at a multiple of 4 is worth about 2 million, before the adjustments we will get to at the end. The reason two owners with the same revenue can get wildly different offers is that buyers argue about both numbers: what really counts as earnings, and what multiple your particular business deserves. Once you understand how each one is set, buyer offers stop being mysterious and start being checkable. That is what the rest of this page walks through, in plain English.

First, the earnings number: SDE or EBITDA?

Before anyone talks multiples, you have to agree on which earnings number you are multiplying. There are two, and mixing them up is the most common way owners get confused about their own value.

SDE stands for seller's discretionary earnings. It is the total benefit one working owner pulls out of the business in a year: the profit on paper, plus your salary, plus the perks the business pays for, plus any one-time costs that will not repeat. SDE is an appraisal and brokerage convention often used to describe one working owner's benefit stream in an owner-operated business. The buyer and its advisors may use a different earnings definition. It answers the question: if I owned this and ran it myself, what would I take home?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. In plain terms: the operating profit of the business before financing costs and accounting noise. Unlike an SDE presentation, an EBITDA-based analysis may include a market-level management cost when the owner performs an operating role. The treatment depends on the buyer's methodology. Your own salary is not added back; if you underpay yourself, a market salary actually gets subtracted. EBITDA is how buyers value bigger shops, usually ones with a real management layer, because they are buying a company, not a job.

SDE and EBITDA can produce different earnings figures because they treat owner compensation and discretionary expenses differently. Neither relationship nor the size of the difference is universal. If you hear a multiple quoted at a trade show, the first question is always "a multiple of what?" Different earnings definitions can make headline multiples misleading. Compare the actual earnings base and estimated proceeds, not the multiple alone. Many financial buyers analyze EBITDA, but the earnings measure used in a specific transaction depends on the company, buyer, and deal structure. Greater scale and management depth may influence valuation, but the dossier does not support a universal multiple step-up for crossing from SDE to EBITDA.

Add-backs: cleaning up the books, with a worked example

Tax reporting and transaction valuation serve different purposes. Buyers commonly analyze whether reported earnings include documented, non-recurring, or owner-specific items. A valuation is built to show the truest one. Add-backs are the bridge between the two: real expenses on your books that a new owner would not have to pay, added back to profit before the multiple is applied.

Here is an illustration in round numbers. Not a real company, just the pattern we see over and over. Say your P&L shows $300,000 in profit:

• You pay yourself $90,000 more than it would cost to hire a manager to do your job. Add back $90,000.
• The business pays for your personal truck, fuel, and insurance. Add back $15,000.
• You paid a one-time legal bill this year that will never repeat. Add back $50,000.

Adjusted earnings: $455,000, not $300,000. At a multiple of 4, that is the difference between a $1.2 million business and a $1.8 million business. Same shop, same year, same trucks. The only thing that changed is that the books now tell the truth.

Two warnings from the other side of the table. First, every add-back needs a paper trail. Buyers accept documented add-backs and quietly discount the fuzzy ones, and a stack of aggressive add-backs makes them distrust the numbers they would otherwise have believed. Second, add-backs cut both ways. If your spouse does the books for free, or your building charges the company below-market rent, a sharp buyer will adjust earnings down for the real cost. Honest adjustments in both directions are what make a valuation stand up in diligence, which is the buyer's line-by-line verification of everything you have claimed.

The multiple: what pushes it up

The multiple is the market's grade on the quality and safety of your earnings. Two HVAC companies with identical adjusted earnings can trade at very different multiples, and the gap usually comes down to a handful of things any owner can work on:

• Recurring service agreements. A book of maintenance contracts is revenue a buyer can count on before the phone rings. A buyer may view documented, renewable service agreements as evidence of repeat revenue. Ask how the buyer measures renewal, churn, and profitability.
• A team that runs without you. If the business hums for two weeks while you are at the lake, a buyer is purchasing a company. If everything routes through your cell phone, they are purchasing you, and you are leaving. Management depth and employee retention can reduce perceived transition risk.
• Clean books. Accrual-based financials, a real accountant, job costing that ties out. Clean books do not just support a higher multiple, they keep the price from eroding during diligence.
• Steady growth. A business that has grown a bit every year, in good markets and bad, tells a buyer the next five years look like the last five. That story is what they are really paying for.
• Size itself. Scale can support a stronger valuation when earnings quality and management depth also hold up. Buyers see more cushion, more team, less risk in any one person or customer. It is one of the quiet reasons waiting a few years and growing can beat selling now.

And what drags it down

• Owner dependence. Owner dependence can increase transition risk and may affect valuation. If you sell the jobs, hold the license, and keep the key relationships, the buyer prices in the risk that value walks out the door with you.
• Customer concentration. If one builder, property manager, or contract is a third of your revenue, the buyer prices in the day that customer leaves. A broad base of smaller customers is worth more than the same revenue from a few big ones.
• Messy records. Cash jobs, personal expenses tangled through the P&L, handshake deals with no paperwork. Unsupported or inconsistent records can create diligence questions and may lead a buyer to adjust its earnings analysis or offer.
• Flat or declining revenue. Buyers will still buy, but they pay for the trend they see, not the turnaround you promise.

Notice that every item on both lists is fixable, given time. Starting early gives an owner more time to improve reporting, document adjustments, and reduce avoidable diligence issues. If you want to see where the market is grading businesses like yours right now, our page on current valuation multiples by industry keeps the ranges up to date.

The fine print that moves real money: working capital and "cash-free, debt-free"

One more piece, because it surprises almost every first-time seller. Private M&A deals are typically discussed on a cash-free, debt-free basis, but the purchase agreement controls the treatment of cash, debt, and working capital. In plain English: you keep the cash sitting in the company's accounts, and you pay off the company's loans and lines of credit at closing, so the buyer gets the business itself, not your bank balance or your debt. But the business still has to be handed over with enough fuel in the tank to operate, the parts inventory, the receivables, the normal cushion of working capital it takes to make payroll and stock the trucks. The buyer will set a working capital target, and if the business comes up short at closing, the difference comes out of your price. It sounds like accounting trivia. The working-capital target and adjustment mechanism can materially change proceeds, so the topic should be addressed before signing the LOI. Two offers with the same headline can put very different amounts in your pocket, and this is one of the places the difference hides. The way offers get packaged, earnouts, seller notes, rollover equity, is its own topic, and we cover it in the deal structure guide linked below.

So what is your business worth?

You now know more about valuation mechanics than most owners ever learn before a buyer is sitting across from them. The formula is simple. The money is in the inputs: which earnings number applies, which add-backs survive scrutiny, and where your multiple lands inside the range. Those are judgment calls, and buyers who have done a hundred deals are very good at making every judgment call lean their way. This is the game every buyer knows cold, and it is learnable. If a letter or a call has already found you, our guide on handling an unsolicited offer is worth ten minutes before you respond to anyone.

If you want a starting point without talking to anyone, run your free Exit Score. In about five minutes, it gives you an industry-specific valuation range and shows which value drivers deserve attention. Use the result to plan well before a buyer conversation, while you still have time to improve the business on your terms.