Every founder has a number in their head. It is usually based on something they read, something they heard at an industry conference, or something a banker told them in a phone call designed to get them to sign an engagement letter. Sometimes the number is based on what they need to retire. Sometimes it is based on what a competitor allegedly sold for two years ago in a very different market environment.

The number in the founder's head is almost always wrong. Not necessarily too high or too low — wrong in the sense that it is based on an incomplete model that does not reflect how sophisticated buyers actually value businesses of this type, at this stage, in this market.

"Valuation is not a calculation — it's a negotiation grounded in a calculation. The multiple a buyer will pay depends on the quality of earnings, the sustainability of cash flow, the strength of the management team, and how much risk the buyer perceives. All four of those are things you can influence long before you go to market."

LJ Govoni — Principal Consultant, Split Oak Advisory Group

How Buyers Actually Value Businesses

The most common valuation methodology in middle-market M&A transactions is a multiple of EBITDA — earnings before interest, taxes, depreciation, and amortization. The multiple is applied to a version of EBITDA that has been adjusted to reflect the true economic earnings of the business: adding back one-time expenses, normalizing owner compensation to a market rate, removing personal expenses run through the business, and making other adjustments negotiated as part of every transaction.

In the lower middle market — businesses with $1M to $5M in EBITDA — multiples for food and beverage, CPG, and manufacturing businesses have historically ranged from 4x to 8x, with significant variance depending on quality factors. The difference between a 5x and a 7x multiple on $3M in EBITDA is $6 million in enterprise value. Understanding what drives that gap — and being deliberate about building toward the higher end — is one of the most important things a founder can do in the years before a transaction.

The Adjustments That Most Founders Miss

The most common source of valuation disappointment is the quality of earnings adjustment. Buyers will scrutinize the financial statements carefully and make their own adjustments to reported earnings. Common adjustments include: normalizing owner and family member compensation to market rates; removing non-recurring revenue or cost items; adjusting for deferred maintenance or capital expenditure requirements; and accounting for customer concentration discounts.

The antidote is a sell-side quality of earnings analysis — conducted by an independent advisor, typically 12 to 24 months before the anticipated transaction — that surfaces these adjustments in advance. Armed with this analysis, a founder can either address the underlying issues before going to market or understand clearly what the adjusted earnings picture looks like.

What Actually Drives Premium Multiples

The businesses that command the highest multiples share a common set of characteristics: revenues that are recurring or highly predictable; customer relationships that are contractual or deeply embedded; margins that have been stable or improving over time; a management team that can run the business without the founder; and financial reporting that is clean, transparent, and detailed.

Notice that none of these characteristics are about the product or the brand. They are about the financial and organizational infrastructure of the business. The implication for founders thinking about an eventual exit is that the work that drives valuation is done in the years before a transaction — not the months before. Buyers pay for track records, not promises.