Three approaches, and why you need more than one
Professional valuation recognises three approaches. They ask different questions, and a business where all three converge is one you can defend. Where they diverge sharply, the divergence itself is the finding.
For most owner-operated businesses the income approach leads and the market approach sanity-checks it. The asset approach usually sets a floor — if a business is worth less as a going concern than its assets fetch at auction, the rational buyer liquidates.
If capitalised earnings say $1.4M, comparable transactions say $1.5M and net assets say $600K, you have a defensible range around $1.4–1.5M with an asset floor well below. If they say $1.4M, $2.6M and $2.2M, you have a question to answer, not a number to average.
The errors that produce wrong numbers
- Rules of thumb used as answers. 'One times revenue' or 'four times earnings' describe a distribution, not a business. They are useful for a first conversation and dangerous as a conclusion.
- Valuing the owner's job. If the business cannot run without the owner, part of what is being valued is employment, and a buyer will not pay a multiple for their own labour.
- Averaging methods that disagree. Averaging $1.4M and $2.6M produces $2.0M, a number no method supports. Reconcile instead — find out why they differ.
- Using unadjusted earnings. Tax-return net income understates a business run for tax minimisation and overstates one with unsustainable add-backs.
- Ignoring working capital. Most transactions convey a normal level of working capital. A valuation that ignores it is answering a different question from the one the buyer is asking.
- Treating a recent bad year as permanent, or a recent good one as the trend. Weighting matters, and so does explaining it.
The most common valuation error is not optimism about the multiple. It is failing to notice that the business and the owner are the same asset.
Getting the earnings right first
Every income-based method multiplies an earnings figure, so an error in earnings is multiplied too. A $30,000 mistake at a 3.5× multiple is a $105,000 mistake in the answer, which is why normalisation deserves more time than choosing the multiple.
| Adjustment | Direction | Why |
|---|---|---|
| Owner compensation to market | Either | Above market adds back; below market deducts |
| Related-party rent to market | Either | Below-market rent flatters earnings |
| One-time items | Add back | Legal settlements, moving costs, storm damage |
| Discontinued activities | Remove | Both revenue and cost |
| Deferred maintenance | Deduct | A cost the buyer inherits immediately |
| Non-operating assets | Remove | Value separately, not through the multiple |
A three-year weighted average is common, often 3-2-1 favouring the most recent year. But if the most recent year contains a one-off contract, or the business changed materially, a mechanical weighting produces a misleading answer. Say which years you weighted and why — an unexplained weighting is the first thing a buyer's accountant will challenge.
Produce a range, then say where you sit in it
A single-point valuation implies a precision that does not exist. What a business is worth depends on who is buying, and a credible valuation says so.
| Buyer type | Values | Effect on price |
|---|---|---|
| Individual operator | A job plus a return | Constrained by lending and their own capital |
| Financial buyer | Cash flow after management | Prices on EBITDA; owner dependence hurts most |
| Strategic buyer | Synergies, customers, capability | Can pay above intrinsic value |
| Consolidator | Scale and platform economics | Often the highest, with structure attached |
The practical output is a range with a stated centre and the reasons for it: $1.35M to $1.65M, centring on $1.45M, with the upper end available to a strategic buyer who values the customer list and the lower end reflecting owner dependence. That is a position you can negotiate from.
01Related toolBusiness Valuation CalculatorEarnings multiples with normalisation and industry ranges.→02Related toolDiscount Rate CalculatorBuild a rate using WACC or the build-up method for the income approach.→