Guides
How to value a small business: SDE, add-backs and the lender's test
A small business selling for under $2 million is usually priced at a multiple of seller’s discretionary earnings (SDE). In Q3 2026, businesses that sold for under $1 million closed at an average of 2.30 times cash flow, and those above $1 million at 3.73 times (BizBuySell Insight Report, Q3 2026). Then the price has to survive the lender. Under the SBA 7(a) rules in force since October 1, 2026, an outside buyer’s target must cover its new debt 1.25 times from historical earnings. Above a $350,000 purchase price, an independent appraiser ordered by the lender must support the price, and anything paid above the appraisal comes from equity (SBA SOP 50 10 8.1, Appendix 15). Multiples by industry are on the valuation multiples page. This page covers the method and works one deal through.
How much is my business worth: the three-step answer
- Recast the earnings. Start from the tax return and add back one owner’s pay and benefits, interest, depreciation, amortization and documented one-time costs. The result is SDE.
- Apply a closed-sale multiple for the right size and industry. Use closed sales, not asking prices. IBBA’s Q2 2026 survey averaged 2.0x SDE for deals under $500,000, 2.8x for $500,000 to $1 million and 3.1x for $1 million to $2 million (IBBA and M&A Source Market Pulse, Q2 2026).
- Check that the price can be financed. 78% of buyers surveyed by BizBuySell in Q3 2026 expected to use SBA financing, so the 7(a) rules are the practical price ceiling for most main-street sales.
SDE vs EBITDA: which earnings figure to use
SDE counts the owner’s salary as profit, because the buyer usually takes over the job and the profit together. EBITDA charges a market salary for whoever runs the business, so it is smaller. IBBA reports deals under $2 million as multiples of SDE and deals of $2 million to $50 million as multiples of EBITDA.
Mixing the two misreads a price by whole turns. The plumbing business in the worked example has $280,000 of SDE and, after a $90,000 manager’s salary, $190,000 of EBITDA. A $750,000 price is 2.68x SDE and 3.95x EBITDA.
The lender works on the EBITDA side. SOP 50 10 8.1 defines historical debt service coverage as “EBITDA divided by the combined debt service post-transaction.” Step 3 below shows the conversion.
Add-backs: what lenders and QoE providers accept and reject
Each add-back raises the price by the add-back times the multiple: on a 2.7x deal, a $20,000 add-back is $54,000 of price. The SOP says “Adjustments to cash flow without the Lender’s supporting analysis and justification will be ineligible.” Where a quality of earnings (QoE) report is required, it must “identify and document all add-backs and adjustments” and include a “Cash Proof” that reconciles bank statements to the income statement and tax return (Appendix 15, C.1). QoE providers trace adjustments to invoices, contracts and payroll records rather than accept the seller’s schedule (EisnerAmper, August 28, 2026).
| Add-back | Lender treatment under SOP 50 10 8.1 | What proves it |
|---|---|---|
| One owner’s salary, payroll taxes and benefits | Accepted, but the buyer’s own salary is subtracted again. Changes to owner pay must pass a global cash-flow test at 1:1 | Payroll records, W-2, tax return |
| Interest, depreciation, amortization | Accepted; they are inside the EBITDA definition | Tax return |
| Capital spending the business needs | Subtracted. “Unfunded capital expenditures” are a listed adjustment | Fixed-asset ledger, equipment age |
| One-time costs (a lawsuit, a storm repair) | Accepted with documentation. The QoE must identify “non-recurring revenue or expenses” | Invoices, settlement papers |
| Personal spending through the business, family on payroll | Accepted only with justification. “Seller discretionary expenses” and “related-party transactions” must each be identified | Card statements, payroll, leases |
| Cash sales not on the tax return | Rejected in practice. The lender checks the seller’s figures against IRS transcripts | Nothing the lender can use |
| Next year’s growth, new contracts, pro forma revenue | Rejected for coverage. The lender “may not rely on” projections (owner-occupied special-purpose property is the exception) | Not countable |
| Savings the buyer will make | Allowed if “prudent,” realizable through the transaction and justified in the credit memo | Quotes, signed contracts |
| Rent on real estate bought in the same deal | Accepted. Lenders “may include an addback for rent payments” | Lease, appraisal |
A QoE is required only for initial acquisitions and expansions priced at $3 million or more. Below that, the lender still has to justify every adjustment in its credit memo.
Small business valuation methods: asset, market and income
The IRS valuation guidelines name “the asset-based approach, the market approach and the income approach” and say all three should be considered, with judgment choosing which to rely on (IRM 4.48.4.2.3, revised 2020 and still current).
- Market approach. SDE times a multiple from comparable closed sales. BizBuySell calls its multiples “a starting point” for business-specific adjustments (BizBuySell).
- Income approach. Capitalized earnings or discounted cash flow. In an SBA deal, the lender’s coverage test is the income test that binds: pass or fail on historical earnings at the actual loan rate.
- Asset approach. What the equipment, vehicles, inventory and receivables would fetch: a floor, and little of a service business’s price. For SBA collateral, used equipment counts at 50% of net book value (80% with an orderly liquidation appraisal), and receivables, inventory and furniture at 10%. When the loan is not fully secured, the lender must take available equity in the owners’ personal real estate (Appendix 15, C.3), which for most service-business buyers means a lien on their home.
SBA 7(a) rules that cap the price in 2026
SOP 50 10 8.1 was published September 25, 2026. It applies to applications issued an SBA loan number on or after October 1, 2026; SOP 50 10 8 still governs applications submitted through September 30 (SBA Information Notice 5000-880695). The rules below are for an “initial acquisition”: a buyer who is not already an owner purchasing 100% of the business. All are from Appendix 15 unless noted.
| Rule | What 8.1 requires | Effect on price |
|---|---|---|
| Equity injection | 10% of total project cost; for an initial acquisition it “cannot be reduced or eliminated” | Buyer cash of about a tenth of price plus costs |
| Seller note as equity | Counts only on “full standby (no payments of principal or interest for the term of the 7(a) loan).” Seller notes and other limited sources may provide “no more than half of the required Equity Injection” | A seller note can replace at most half the buyer’s 10% |
| Seller note not on standby | Its payments enter the coverage test; interest-only debt is amortized over no more than 10 years. Total debt, seller debt included, “is limited to the business valuation amount” | Seller carry-back cannot push total debt above the appraisal |
| Independent valuation | Required above a $350,000 Business Purchase Price (or with a close buyer-seller relationship), from an ASA, CBA, ABV, CVA or BCA. “The Lender may not use a business valuation prepared for the Applicant or the seller” | Price above the appraisal “must be made up by equity” |
| Quality of earnings | Required for initial acquisitions and expansions at $3 million or more, with a Cash Proof over the trailing 12 months and two fiscal years | Coverage is tested on QoE earnings; the loan is cut if they fall short |
| Debt service coverage | 1.25:1 for an initial acquisition (1.15:1 for a business expansion), on the last fiscal year or the average of the last two. Projections cannot be used | The hard ceiling on loan size |
| Earnouts and seller stay | “Seller earnouts are prohibited.” The seller may consult for no more than 24 months | No contingent price in an SBA deal |
| Term and rate | Amortization of up to 10 years. Variable rate capped at prime plus 3.0% for loans over $350,000 (Section B). Maximum Standard 7(a) loan $5 million | Prime was 7.00% on October 26, 2026 (FRED), so the cap is 10.00% |
What changed on October 1, compared with SOP 50 10 8 (effective June 1, 2025): coverage rose from 1.15 to 1.25 for acquisitions, and projections no longer count. The independent-valuation trigger moved from $250,000 of financing (net of appraised real estate and equipment) to a $350,000 purchase price. The QoE requirement is new. The seller’s consulting period went from 12 months to 24. In BizBuySell’s Q3 2026 survey, brokers named SBA funding as their most common financing obstacle (38%), ahead of interest rates (34%).
Worked example: valuing a plumbing business with SDE and an SBA loan
The business is hypothetical, modeled on BizBuySell’s 2025 plumbing sales: median revenue $1,044,630, median cash flow $278,498, an average of 2.62x cash flow across 61 sales (BizBuySell data tables, full-year 2025). Ours has $1.1 million of revenue and an owner who works in it full time.
Step 1: recast SDE from the tax return.
| Line | Amount |
|---|---|
| Net income on the tax return | $142,000 |
| Owner’s salary | $95,000 |
| Owner’s health insurance | $12,000 |
| Interest on the existing truck loan | $6,000 |
| Depreciation | $22,000 |
| One-time legal settlement (documented) | $3,000 |
| SDE | $280,000 |
Step 2: apply closed-sale multiples.
| Benchmark | Multiple | Value at $280,000 SDE |
|---|---|---|
| BizBuySell plumbing, 2025 closed sales (61) | 2.62x | $733,600 |
| BizBuySell plumbing, five-year average (Q3 2021 to Q2 2026) | 2.61x | $730,800 |
| IBBA $500,000 to $1 million band, Q2 2026 | 2.8x | $784,000 |
The range is about $730,000 to $785,000. We offer $750,000, or 2.68x SDE, and in an SBA deal that is also where the appraisal needs to land.
Step 3: convert SDE to the cash the lender counts. $280,000 of SDE minus a $90,000 salary for the buyer is $190,000 of EBITDA. Setting aside $15,000 a year to replace trucks and tools leaves $175,000 for debt service. Both figures are assumptions. The BLS median wage for plumbers was $63,800 in May 2025 (BLS), and an owner who also runs the office should be paid more.
Step 4: sources and uses.
| Uses | Sources | ||
|---|---|---|---|
| Purchase price | $750,000 | Buyer cash (10%) | $82,448 |
| Working capital | $40,000 | SBA 7(a) loan | $742,030 |
| Valuation, legal and closing costs | $15,000 | ||
| SBA guaranty fee | $19,478 | ||
| Total project cost | $824,478 | Total | $824,478 |
The loan is 90% of the project: 0.9 × ($805,000 + $19,478) = $742,030. The guaranty fee is 3.5% of the 75% guaranteed portion, 3.5% × 75% × $742,030 = $19,478, the rate SBA set for loans of $700,001 to $5 million in fiscal 2027 (SBA Information Notice 5000-881797).
Step 5: the coverage test. At the 10.00% rate cap over 120 months, the payment on $742,030 is $9,806 a month, or $117,672 a year. Coverage is $175,000 ÷ $117,672 = 1.49, which passes the 1.25 minimum. At 12.00%, debt service is $127,752 and coverage 1.37, still a pass.
Coverage alone would allow $140,000 of debt service ($175,000 ÷ 1.25), a loan of about $882,800, and on the same structure a price of about $903,000, or 3.22x SDE. In this deal the appraisal, not coverage, sets the ceiling.
Step 6: the over-ask. The seller has read about “4x” plumbing multiples and wants $950,000, or 3.39x SDE. If the lender’s appraiser concludes $750,000, the $200,000 above it “must be made up by equity.” The loan stays at $742,030, and the buyer’s equity rises from $82,448 to $282,448. A seller note can supply part of that only if it is on full standby, receiving nothing for the ten-year life of the loan.
Mistakes buyers make when valuing a small business
- Pricing off asking multiples. In Q3 2026, businesses under $1 million sold for an average of 93.6% of asking price (BizBuySell). Use closed sales.
- Putting an EBITDA multiple on SDE. A “4x” quoted for a larger company, applied to a small company’s SDE, adds a turn or more to the price.
- Relying on your own appraisal. The lender cannot use a valuation prepared for the buyer or the seller, so it orders its own, and the SOP lets it pass that cost to you. A QoE you commissioned yourself is different: the lender may have one of its vendors review it instead of starting over.
Building the comps side of a deal
Hyperresearch can build the market side of a valuation as a cited report: closed-deal multiples for the industry, the local market and competitors, active buyers in the trade, and current SBA terms, with every citation checked against its source. A Deep run is $49, and the first is free once you add a card. The HVAC acquisition sample shows one for a $2 million-revenue company. It reads public sources only, so the SDE recast, the QoE and the appraisal still come from the seller’s records, your CPA and the lender’s appraiser. For the market questions to answer before you sign, see commercial due diligence for a small acquisition.