5 Ways Small Business Owners Accidentally Undervalue Their Company

One of the significant truths that impacts a selling business is that most owners walk away disappointed. Even after boring years of life and efforts into building a profitable operation, you may not get a fair reward. 

CNBC’s report also stated that 80% to 90% of business leaders have their financial wealth locked up in their organizations. Many small business owners, true no fault of their business acumen, accidentally undervalue their companies. 

Making simple calculation errors, looking at key non-financial assets, or applying the wrong method might create a blunder. Therefore, understanding these common mistakes is vital in the first step to protect the wealth fuel to be an established business. 

Let’s comprehensively learn five ways small business owners undervalue their companies.

KEY TAKEAWAYS

• Mistakes start from forgetting to add back on compensation to not accounting for buyers’ needs.
• Keeping an eye on these mistakes is critical. 
•  Make sure you get your valuation right from the start

1. Forgetting to add back owner compensation and perks

Most small business owners pay themselves in methods that don’t show up clearly on financial statements. You might take a subtle salary but run personal expenses through the business. Or you pay yourself less than the market rate because you can. Maybe you employ family members at above-market incomes.

Buyers don’t care about the way you structured your compensation. They look up the actual cash the business generates for its owner. This is known as Seller’s Discretionary Earnings or SDE.

SDE counts your net profit, plus your salary and benefits, plus personal expenses run through the business, plus any discretionary spending. For many small businesses, these add-backs are significant.

Here’s a common scenario. Your organization shows $150,000 in net profit on the tax return. But you also paid yourself a $80,000 salary. You run your car lease ($12,000 annually) via the business. You employ your spouse who does minimum work for $40,000. Your health insurance ($18,000) comes from the business.

Your actual SDE is not $150,000. It’s $300,000.

At a 3x multiple, forgetting these add-backs refers to valuing your business at $450,000 instead of $900,000. That’s a $450,000 problem.

How to fix it: Maintain a detailed account of all owner benefits and personal expenses. Keep distinctive documentation showing what’s truly necessary for operations versus what’s discretionary. Calculate your entire SDE before talking to any buyer or advisor. Understanding  how to value a company for sale properly involves getting these calculations right from the start.

2. Using the wrong valuation multiple for your industry

Business owners usually grab a multiple they heard somewhere and apply it to their incomes. “I heard businesses sell for 3x profit” or “someone told me to use 5x revenue.”

The issue? Multiples vary drastically by industry, business size, and specific characteristics.

Different industries command different multiples:

Industry Type	Typical SDE Multiple
SaaS/Software	4x – 6x
E-commerce	2.5x – 3.5x
Service businesses	2x – 3x
Manufacturing	3x – 4x
Healthcare services	3.5x – 5x

Size also matters:

Annual SDE	Typical Multiple Range
Under $250,000	1.5x – 2.5x
$250,000 – $500,000	2x – 3x
$500,000 – $1 million	2.5x – 3.5x
Over $1 million	3x – 4x+

An e-commerce trade with $400,000 SDE might realistically sell for 2.5x to 3x, or $1 million to $1.2 million. In case the owner assumes a 5x multiple because that’s what tech companies get, they might be expecting $2 million. That’s not just optimistic – it’s a deal breaker.

How to fix it: Research real sale prices in your specific industry and size range. Look at business-for-sale marketplaces like Flippa, BizBuySell, or Empire Flippers for comparable transactions. Talk to brokers who have expertise in your industry.

3. Ignoring intangible assets that buyers will pay for

Small business owners focus on tangible numbers – revenue, equipment, profit, inventory. They overlook intangible assets that significantly raise value.

The customer database is an asset. If you have 5,000 consumers with email addresses and purchase history, that’s valuable. Your brand value matters. Long-term contracts provide predictable revenue. Additionally, the trained staff is valuable if they can run operations without you. Permits, licenses, and certifications that are hard to obtain increase value.

Here’s an example. Two consulting businesses each generate $300,000 in SDE:

Business A:

• No long-term contracts
• Owner does all client work
• Standard processes
• Value: $600,000 (2x multiple)

Business B:

• 60% revenue under multi-year contracts
• Team of 5 can deliver without owner
• Proprietary methodology documented
• Value: $1,050,000 (3.5x multiple)

The difference is not in the current earnings. It is in the intangibles that make Business B less risky and easier to operate.

How to fix it: Create a list of every intangible asset your business has. Document your processes in writing or video. Get long-term contracts in place before selling. Build systems that lowers dependence on you personally. Professional bookkeeping services support you track and present these assets effectively.

4. Calculating profit incorrectly or using the wrong financial metric

Many small business owners are not accountants. They look at what’s in the bank account or what their tax return shows and call that profit. This gives massive valuation errors.

Some use revenue rather than profit. Others confuse cash flow with profit. The biggest mistake is not acknowledging EBITDA versus SDE.

EBITDA calculation:

• Revenue minus costs minus operating expenses (excluding owner salary at market rate) plus back interest, depreciation, taxes, amortization

SDE calculation:

• Revenue minus costs minus operating expenses plus back owner salary and benefits plus owner perks plus discretionary expenses plus interest, depreciation, taxes, amortization

For the same business, SDE is typically higher than EBITDA since you add back more items. But EBITDA multiples are also higher. Using the wrong metric with the incorrect multiple compounds the error.

You’d value the business significantly too high if you mistakenly apply a 4x EBITDA multiple to your SDE. Buyers will correct this instantly, ruining your credibility.

How to fix it: Learn the difference between revenue, profit, EBITDA, cash flow, and SDE. For businesses under $5 million in revenue, use SDE. For larger businesses, use EBITDA. Ask for help from professional accounting services to calculate these correctly.

5. Not accounting for what buyers need to invest after purchase

Business owners consider what the business is worth today. Buyers think about what they will need to invest to keep it running.

If you are the sole person who can deliver the service, buyers need to hire someone as your substitute at $100,000 annually. They will reduce their offer to account for this. Buyers will deduct that cost if your equipment is old and needs replacement soon. 

In case you have been putting off technology upgrades, buyers see that as a cost they will inherit. If customer contracts are expiring soon, that’s a risk they’ll price into their offer.

Here’s an example:

Item	Amount
Expected value (SDE $400K at 3x)	$1,200,000
Replace owner with manager	-$270,000
Replace delivery vehicles	-$60,000
Upgrade systems	-$25,000
Lease renewal premium	-$45,000
Adjusted buyer offer	$800,000

The owner sees a $1.2 million business. The buyer sees $400,000 in near-term investment needs and adjusts accordingly.

How to fix it: watch out for your business through a buyer’s eyes. Replace aging equipment prior to listing. Renew key contracts before going to market. Execute systems that reduce owner dependence. Document processes so buyers do not need expensive consulting. The more “turnkey” your business, the more buyers will pay.

Getting your valuation right from the start

These five errors cost business owners significant money during sales. The good news is they are all fixable with proper preparation.

Commence by calculating your true SDE with all legitimate add-backs documented. Research multiple specific to your industry and business size. Determine and document your intangible assets. Make sure you are using the right financial metrics correctly. Plus, honestly assess what buyers will need to invest after purchase.

The time to get your valuation is just before you start talking to buyers, not during negotiations. Do the work upfront, fix the problems, and you will get offers that reflect your business’s true value.

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