How do I value my business?

Valuing a business is an important first step in the sales process. Several legitimate methods exist and the right method depends on the company and the purpose. Iris Co. will work through those methods and their use cases in a later post. For most lower-middle-market businesses thinking about a future sale, the workhorse method is an EBITDA multiple. That is what an Iris Co. Estimate of Value (EOV) is built on, and the rest of this post walks through how it actually works, end to end.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The base formula is straightforward:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

EBITDA is a measure of operating cash earnings that strips out financing decisions (interest), taxes, and non-cash accounting charges (depreciation and amortization). It is a decent approximation for how much cash a business generates from operations. The number on a tax return is almost never the number a buyer values, because tax-return earnings reflect many large and small choices made to minimize tax — not to reflect economic earnings. The first job in valuation is normalizing EBITDA so it shows what the business actually generates under arm's-length, ongoing operating conditions. That output is Adjusted EBITDA:

Adjusted EBITDA = EBITDA + Add-Backs − Reductions

The work is in the add-backs and reductions. Most of the analytical effort in an Estimate of Value is in identifying and quantifying them correctly, and getting a reasonable final number depends on getting them right. 

Owner compensation is always an important adjustment. Many owners pay themselves above or below what a hired manager would cost, often deliberately for tax planning. If an owner draws $400,000 from a business that would require a $200,000 hired manager to replace, the $200,000 difference is added back. Conversely, if an owner pays themselves $80,000 for work that would cost a buyer $200,000 to replace, $120,000 is subtracted. The objective in either direction is the same: show what the business would generate under normal third-party management. This adjustment also captures spouses and family members on the payroll whose compensation does not match the work performed.

Personal and discretionary expenses running through the business are the second category. Vehicles, fuel, family cell phones, country club dues, personal travel, meals that are personal rather than business — these reduce reported EBITDA but would not continue under new ownership. Items that are technically business expenses but reflect owner preference rather than operational necessity — sponsorships, charitable contributions tied to the owner's relationships, certain memberships, and travel beyond what operations require — get added back when a buyer would not continue them.Each gets added back, with documentation. Buyers and their accountants will scrutinize these during due diligence, so the discipline of documenting them up front prevents issues later.

Non-recurring items are the third category. One-time legal settlements, natural disasters and pandemics that disrupt operations (remember COVID?), one-time costs associated with a failed product launch, PPP loan forgiveness on the income side — these distort a single year's EBITDA and need to be carefully considered and adjusted. The test is whether the item is reasonably likely to recur under ongoing operations. One-time professional fees, relocation costs, and insurance recoveries from prior events all fit here.

Related-party rent is the fourth category and a common source of overlooked value. When the operating company rents real estate from an entity owned by the same family, the rent is often set above or below market rate for tax reasons. If the company pays $200,000 in rent for a building that would lease for $120,000 in an arm's-length transaction, $80,000 is added back to EBITDA — and the real estate is valued separately. 

There are also potential accounting-method changes, deferred maintenance, severance payments to former employees after a reorganization, and similar one-off cleanups. These get handled case by case.

Once Adjusted EBITDA is established, the multiple is what a buyer pays per dollar of that earnings number. For most small businesses, multiples generally fall in a 3x to 6x range, with the exact number depending on many factors: industry (recurring-revenue services trade higher than project-based contracting), size (a $5M EBITDA business commands a higher multiple than a $1M EBITDA business — the size premium is real), growth, customer concentration, depth of the management team, recurring versus one-time mix of revenue, quality of financial records, and competitive position. Strategic buyers — companies in the same industry — sometimes pay a turn or two above financial buyers because they can extract value beyond what the standalone business generates. Heavily owner-dependent businesses get discounted because the buyer will have to find a way to replace an owner. Often, owners provide more than just leadership to an organization - they are simultaneously managing, selling, providing a vision for the future, and the organization’s historian.

The first valuation step combines the two:

Enterprise Value = Adjusted EBITDA × Multiple

Enterprise Value is the value of the operating business itself, debt-free and cash-free. It is not what the seller takes home. To get from enterprise value to equity value, the company's actual capital structure has to be reflected:

Equity Value = Enterprise Value − Interest-Bearing Debt + Excess Cash ± Working Capital Adjustment

Interest-bearing debt — bank notes, equipment loans, lines of credit, equipment leases — gets subtracted because the buyer either assumes it or it is paid off at/prior to closing. Excess cash gets added back because the seller keeps cash above what the business needs to operate. The working capital adjustment reflects the negotiated level of working capital the seller delivers at close; if the actual delivered working capital is below the agreed peg, the difference comes out of the price, and the inverse is true if the delivered amount is above (more on working capital in a future post).

Equity Value is still not the seller's net proceeds. Two more reductions apply:

Net Proceeds = Equity Value − Transaction Expenses − Taxes

Transaction expenses include legal fees, M&A advisory fees (hopefully Iris Co.), accounting and quality-of-earnings work, and any escrow or indemnity holdbacks that sit out for some period after close. Taxes depend heavily on deal structure — asset versus stock sale, allocation of purchase price across asset categories, treatment of personal goodwill, state tax exposure. Two transactions with identical enterprise values can produce dramatically different after-tax results depending on how the deal is structured. Effective tax planning starts well before a sale process begins, ideally several years out, and is one of the highest-leverage activities a seller can pursue with their CPA.

The output of an Iris Co. Estimate of Value is a defensible range, not a single point estimate. Multiples sit in a band, not on a line — buyers price risk differently, and the market reflects that. The range gives owners and their advisors something real to work with: a market-grounded answer to "where do we stand today" that supports planning, partner conversations, buy-sell reviews, and retirement modeling.

If you are an owner wondering what your business is worth, or an advisor whose client just asked the question, the EOV is usually the right starting point. At Iris Co. We strive to provide a value to our clients’ businesses as a data point, as an aid to decision making, and as a litmus test of an owner’s readiness to sell.  Contact us if you’d like to learn more.

This post is for general informational purposes only and does not constitute legal, tax, financial, or investment advice. Every business and transaction is different; readers should consult qualified advisors regarding their specific situation.