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Executive Summary: Understanding and applying industry-specific valuation multiples is fundamental to accurately assessing the value of a small business. While metrics like EBITDA and Seller’s Discretionary Earnings (SDE) are commonly used in private company valuations, the appropriate multiple can vary significantly depending on the industry. In this article, we explain how these multiples are derived, why they differ by sector, and how misapplying them can lead to overpaying—or undervaluing—a business. This insight is essential for business owners, investors, advisors, and anyone seeking a well-grounded valuation.

Introduction

Valuation multiples are an essential tool for estimating what a business is worth, particularly in market-based valuation approaches. But not all multiples are created equally. Multiples vary by financial metric, deal size, business risk, and—perhaps most significantly—by industry. For small businesses in particular, using the correct industry multiple is critical to arrive at a realistic and defensible valuation. A restaurant valued using technology sector benchmarks, for example, will yield inaccurate conclusions and distort investor expectations.

Why This Topic Matters

Applying the right multiple is more than a technical detail—it directly influences a company’s perceived market value. Banks use these numbers when evaluating a loan-backed acquisition. Buyers rely on them when comparing opportunities across sectors. Owners make strategic decisions based on how much their company might sell for when the time comes to exit.

Failure to understand the nuances of industry-specific multiples can cause costly misjudgments in buy-sell transactions, partnership buyouts, succession planning, and more. For example, using a generic 3x EBITDA multiple across all service businesses ignores critical factors like customer retention, regulatory dependence, or recurring revenue—attributes that can push the multiple up or down significantly.

Key Valuation Insights

How Industry Multiples Are Derived

Industry multiples are typically developed from market data based on actual transactions, adjusted for size, risk, and market conditions. Professional databases such as Pratt’s Stats (DealStats), Pitchbook, or GF Data collect sale prices and financial metrics from thousands of reported deals. Analysts review this data to identify median and average multiples by industry group, often segmented further by revenue tiers or profitability metrics.

These comparables offer a starting point—a benchmark. However, credible valuation work doesn’t stop there. Valuation professionals also consider economic trends, company-specific risks, buyer types (strategic vs. financial), and growth expectations.

Choosing Between SDE and EBITDA Multiples

SDE (Seller’s Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) are both useful earnings bases in small business valuations, but the choice depends on the subject company and buyer type.

SDE is commonly used for owner-operated businesses where the buyer is expected to replace the seller’s role. This metric adds back the owner’s salary, one-time expenses, and some discretionary spending. EBITDA is more appropriate when estimating value for firms with professional management teams or where the owner’s compensation isn’t directly tied to operations—this is often the case for middle-market companies and institutional buyers.

Importantly, SDE multiples are generally lower than EBITDA multiples for the same company, often by as much as 1.0 to 2.0 turns. This reflects the higher operating risk facing owner-operated enterprises.

Factors That Influence Multiple Ranges

Industry is just one of several factors that shape the multiple a business might fetch. Others include:

• Size of the business: Companies with higher revenues and profits tend to attract higher multiples due to economies of scale and broader buyer interest.
• Profit margins and cash flow: Higher margins and consistent cash flow reduce operational risk, translating into premium multiples.
• Customer concentration: Heavy reliance on a few customers can depress multiples, especially in contract-based industries like government services or niche manufacturing.
• Recurring revenue: Industries with subscription or contracted revenues (e.g., SaaS, managed IT services) often command higher multiples due to predictable income streams.
• Regulation and compliance: Sectors like healthcare or finance might face downward multiple adjustments due to heightened oversight risks despite high demand.

Real-World Applications

Consider two businesses, both generating $1 million in seller’s discretionary earnings: one is a residential HVAC contractor, the other is an online retail apparel brand. Based on historical deal data, HVAC service companies may fetch SDE multiples of 2.5x to 3.5x, thanks to recurring maintenance contracts and year-round demand. In contrast, a consumer apparel e-commerce store—where customer loyalty is lower and seasonal demand spikes—might trade closer to 1.5x to 2.5x SDE, despite similar earnings on paper.

In professional practice, valuation analysts will start with these observed industry ranges but adjust them based on company-specific factors. A well-documented HVAC firm with 30% service contract revenue and low customer churn might warrant a premium multiple above the industry median. Similarly, a fast-growing e-commerce apparel brand with factory-direct supply chain advantages and high margins could lean toward the upper end of its narrower multiple range.

Common Mistakes or Misconceptions

Assuming One Size Fits All: A frequent misstep in DIY valuations is applying a “rule of thumb” multiple (e.g., 3x EBITDA) without regard for industry or company specifics. While these shortcuts may help initiate conversations, they rarely withstand due diligence.

Overlooking Normalization Adjustments: The income base used in calculating value must be normalized for one-off expenses, owner perks, non-operating income, and above/below-market compensation. Failing to adjust these inputs renders any multiple application meaningless.

Confusing Revenue and Earnings Multiples: Revenue multiples are more appropriate in industries where companies are pre-profit or where operational scale determines future income potential (e.g., tech startups). For most mature small businesses, though, SDE or EBITDA multiples reflect true earnings power and are more instructive.

Misinterpreting Multiples as Absolute: Buyers and advisors must remember that multiples are derived from the market—not dictated by it. Multiples rise or fall with broader financial markets, interest rates, and perceived forward-looking risk. Blindly relying on last year’s metrics without adjusting for today’s economy can yield inflated valuations.

Conclusion

Valuation multiples provide a practical, market-facing way to estimate what a small business is worth—but only when used thoughtfully and in context. Industry benchmarks offer an excellent starting point, but precision comes from adjusting those benchmarks to fit the nuances of the specific business, market conditions, and risk profile.

For business owners contemplating a sale, succession plan, or equity restructuring, understanding how the market values companies in their specific sector is a critical step in setting expectations and making informed decisions.

If you’re a business owner seeking clarity on your company’s value—or exploring next steps in your growth or exit strategy—our team of certified valuation experts can provide a thorough, industry-aligned appraisal tailored to your unique circumstances. Contact us today to schedule a confidential discussion about your situation.