If you’re thinking about selling your business, one of the first questions you’ll ask is: What is my business worth?

Most business owners have a number in mind - sometimes based on gut feel, sometimes based on what they need for retirement, and sometimes based on what a friend sold their business for. The reality, however, is that buyers use a very different lens when determining value.

Let’s break down how business valuation actually works and why there’s often a gap between what a seller expects and what a buyer is willing to pay.

How Business Buyers Think About Valuation

The simplest way to think about valuation is: How much free cash flow does the business generate, and how predictable is that cash flow in the future?

Buyers don’t just look at revenue or net profit - they want to know what they’ll actually get in return for their investment, and how risky that investment is. A business that produces consistent, predictable cash flow with a strong operational structure will always be worth more than one that is unstable or overly dependent on the owner.

Here’s what goes into their thinking:

  • Profitability matters more than revenue. A R10 million revenue business with R500,000 in profit is worth a lot less than a R5 million revenue business with R2 million in profit.
  • How involved are you as the owner? If your business can’t function without you, buyers see risk - and they discount the price accordingly.
  • The industry you operate in affects multiples. Stable, high-margin industries command higher valuations than those with high competition or regulatory risk.
  • Does the business generate strong free cash flow? Businesses with erratic cash flow are harder to value and finance, making them less attractive to buyers.

Common Valuation Methods Buyers Use

There are a few different ways to value a business, but for owner-operated small businesses, the most common approach is a multiple of profit (EBITDA or Seller’s Discretionary Earnings).

1. The Multiple Method (EBITDA or SDE-Based)

Most businesses are valued based on a multiple of profit - typically using either EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) or SDE (Seller’s Discretionary Earnings), which includes an owner’s salary and benefits.

For example, if your business generates R3 million in EBITDA and the market multiple for businesses of your size and industry is 3.5x, then the business would be worth approximately R10.5 million.

Larger businesses and those with strong systems, recurring revenue, and an independent management team tend to command higher multiples, whereas businesses that rely heavily on the owner, have messy financials, or operate in highly competitive industries will have lower multiples.

2. The Free Cash Flow Method

This method looks at how much money the business generates after covering all expenses, taxes, and working capital needs. It helps buyers determine how much actual cash they’ll receive and whether they can use that cash to finance the purchase.

If a business generates R4 million per year in free cash flow and the buyer needs to finance the deal, they’ll calculate whether the business can comfortably pay off a loan while still providing a return on investment.

3. Asset-Based Valuation (For Asset-Heavy Businesses)

In industries with high-value equipment, property, or inventory, the business may be valued based on the sum of its tangible assets minus liabilities. However, most service-based and cash-flow-driven businesses are valued on earnings, not assets.

What About Working Capital?

One of the biggest misunderstandings in small business sales is the role of working capital - the cash, stock, and debtors needed to keep the business running. Many sellers assume they’ll take all the cash out of the business when they sell, but buyers expect a business to come with the working capital it needs to operate.

For example, if your business needs R1 million in working capital to keep running, a buyer will expect that to stay in the business. If not, they’ll reduce their offer accordingly. Understanding this helps avoid surprises late in the deal process.

Bridging the Gap Between Seller and Buyer Expectations

Most business owners overestimate the value of their business, often because they focus on what they need from the sale, rather than what the business is worth to a buyer.

A few ways to increase your valuation and close the gap:

  • Ensure clean financials - Buyers discount businesses with poor record-keeping.
  • Reduce owner reliance - If your business can’t run without you, buyers see risk.
  • Demonstrate stable cash flow - Erratic profits make valuation trickier.
  • Prepare working capital expectations in advance - so there are no surprises.

Understanding valuation from the buyer’s perspective makes negotiations easier and helps you position your business for a smoother, more profitable exit.

If you’re considering selling and want an indication of what your business could be worth, a high-level valuation is a great place to start.