Choosing a valuation method: a decision path

No method is right in general. Each one answers a specific question well and other questions badly. The choice comes down to three facts about the engagement: how big the company is, how stable its earnings are, and who is likely to buy it. Work through those in order and the method usually chooses itself.

Start with size

Size determines which market the company trades in, and each market has its own pricing convention. Owner-operated companies — roughly $250,000 to $5 million in revenue, sold to individual buyers — trade on multiples of seller's discretionary earnings. Reported transactions in this band average about 2.58 times SDE across all sectors, and the median sale price is $340,000. The natural primary method here is themultiple of discretionary earnings, because it prices the thing the buyer is actually purchasing: a job plus a return, bundled together.

Once a company has professional management and EBITDA above roughly $1 million, the buyers change. Search funds, private equity, and strategic acquirers price on EBITDA, and lower-middle-market deal data puts those multiples at 4 to 6 times and sometimes higher. At that size, capitalized earnings or adiscounted cash flow becomes the primary tool, with owner compensation normalized rather than added back.

Then earnings stability

Stability decides whether history can stand in for the future. If the last three to five years look alike and next year should too, a single stabilized earnings figure is honest, and capitalized earnings converts it to value in one clean step. If the future will not resemble the past — a signed contract, new capacity, a recovery from a loss year — no single historical number represents earning power, and you need the DCF's year-by-year forecast, with all the discipline that a forecast demands.

Volatile earnings with no story behind the swings are the hard case. Averaging several years helps some. Weighting the market approach more heavily helps too, since comparable sales price businesses with similar volatility baked in. And when earnings are weak or negative outright, the income approach has little to say; adjusted book value moves from cross-check to center stage.

Then the likely buyer

The method should mirror how the eventual buyer will think. An individual using SBA financing thinks in SDE and debt service coverage. A financial buyer thinks in EBITDA and returns on invested capital. A strategic acquirer thinks in synergies, which no formula sees, but which make market comparables from strategic deals worth collecting. In a dispute there is no buyer at all, only a hypothetical one, and courts tend to favor methods with visible support — which is a reason to favor the excess earnings method when goodwill must be allocated, as in a divorce matter.

The short version

Owner-operated and stable: discretionary earnings multiple, checked against comps. Managed and stable: capitalized earnings. Changing materially: DCF. Asset-heavy or unprofitable: adjusted book value. Whatever the case, the asset approach sets the floor.

Run more than one anyway

Choosing a primary method is not the same as running only one. A credible valuation applies two or three, weights the indications, and states the reason for each weight. The secondary methods are not decoration; they are the error check. If the earnings multiple says $900,000 and the comps say $500,000, one of your inputs is wrong, and finding it now is far cheaper than having a buyer's accountant find it later. ExitSight runs all seven methods from the same recast statements, so the cross-check costs nothing but the reading.