Business valuation is always front of mind for business owners and investors, but how does it work. We regularly get questions like – How is AR and inventory treated? Do I get to keep the cash? What happens to the debt? What is DCF? Not to worry. In this article, we explain the different valuation methodologies, with examples.
The three approaches
In practice, companies are valued three ways: by what the market is paying, by the cash they’ll generate, or by what their assets are worth. A company’s valuation is based on the facts of the business, rather than a one-size-fits-all formula. Below, we will discuss the methodologies for valuing a business :
The Market Approach:
The Market Approach derives value from comparable M&A deals and, in some cases, public-company multiples (primarily for businesses valued at $250M+). In most $10M–$100M EV deals, buyers anchor on Enterprise Value (EV) = Adjusted EBITDA × Market Multiple. Enterprise value captures the value of the business regardless of capital structure, equaling the market value of equity plus debt minus cash. In Practice, transactions are typically cash-free, debt-free, meaning that the seller typically gets to keep the cash within the business, but also must pay off the debt. Our primer on Adjusted EBITDA explains standard adjustments, such as owner compensation and nonrecurring items. Buyers trust these adjustments more when a Quality of Earnings report is available.
The Market Approach in Practice
Example Company: Tech-enabled B2B services provider generating roughly $45M in revenue and $7M in adjusted EBITDA. The business is growing at double-digit rates, maintains low customer concentration, and has a deep leadership bench that extends well beyond the founder.
- Market: Relevant private‑deal comps indicate 6x-7x EV/EBITDA.
- Calculation: $7M × 6 = $42M; $7M × 7 = $49M → EV $42–$49M.
- Income (Discounted Cashflow): 10–12% CAGR for three years, then 3% terminal growth; discount rate in the low‑teens → EV ~$41–$47M.
- Asset: Adjusted net assets $12–$14M.
Why the Market Approach leads in this scenario: There is a broad set of comparable transactions for profitable, growing services firms, and lenders and boards tend to reference those multiples.
The Income Approach:
The Income Approach converts future expected cash flow into a present value. This approach is most used when forecasts reliably show your future differs from your past. It’s less common in the lower-middle-market due to less reliable projections.
The Income Approach in Practice:
Example Company: Multi-site provider with approximately $120M in revenue and $15M in adjusted EBITDA. The company has grown at a predictable rate historically, and recently signed multi-year customer contracts, is bringing new capacity online, and has a credible plan that makes the future meaningfully different from the past.
- Income (Discounted Cash Flow): 15–18% revenue growth for three years, tapering to 3% terminal growth; discount rate ~11–12%; terminal value cross‑checked with a conservative exit multiple → EV ~$120–$135M.
- Market: Larger peers at 7x–8x EV/EBITDA.
- Calculation: $15M × 7 = $105M; $15M × 8 = $120M → EV $105–$120M.
- Asset: Adjusted net assets $25–$30M.
Why the Income Approach leads in this scenario: The forecast is supported by consistent historical financials and future projections with credible backing (contracts/backlog/capacity), so a DCF (Discounted Cash Flow) captures value not yet reflected in comparable transactions.
The Asset Approach:
The Asset Approach values a business as assets minus liabilities (or, at times, liquidation value). This approach is useful when assets, rather than earnings, drive value, or when a company is underperforming.
The Asset Approach in Practice:
Example Company: Civil/utility general contractor with an equipment-intensive model, producing about $70M in revenue and $3M in adjusted EBITDA. The company’s backlog is solid but cyclical, and earnings are volatile, driven by equipment utilization and project activity.
- Asset: Appraised rolling stock, yard equipment, and normalized working capital at market less liabilities.
- Example: Equipment Fair market Value (FMV) $18M + Net Working Capital (NWC) $6M − debt $5M = Adjusted net assets = $19M
- Market: Smaller/volatile peers at 3.5x–4.5x EV/EBITDA.
- Calculation: $3M × 3.5 = $10.5M; $3M × 4.5 = $13.5M → EV $10.5–$13.5M.
- Income: Cash flow is discounted at a higher rate due to cyclicality; utilization drives margins → EV ~$9–$11M.
Why the Market Approach leads in this scenario: Tangible equipment and working assets outweigh the value implied by low, volatile earnings.
Which method usually yields the highest or lowest value and why
Generally, most businesses are valued using the multiples approach. However, each approach yields different results depending on a company’s specifics. Understanding how these methods differ, and why a buyer may select one over another, is key to interpreting valuation outcomes. Think of the Asset Approach as the floor, providing a baseline value grounded in tangible assets. The Market Approach acts as a compass, guiding value based on the direction of comparable sales. Meanwhile, the Income Approach serves as a telescope, focusing on future potential and growth beyond the present data.
- Lowest: The Asset Approach usually gives the lowest valuation. For asset-heavy or underperforming firms, it can be highest if tangible assets exceed the value implied by low earnings.
- Middle (anchor): The Market Approach is typically viewed as the most “fair” way to value a business. In some cases, it may lead to the highest value when growth is unpredictable or if a control premium exists.
- Potentially Highest: The Income Approach can yield the highest value if there’s well‑supported growth or margin expansion not reflected in historical results.
These patterns show that each method values different aspects of a business. The right method depends on whether a company’s value is best represented by its assets, market comparables, or future earnings potential, but it’s important to note that there’s not always one right answer for any business, which is why running a competitive process is crucial to drive the highest valuation for your business.
If you’ve read our guides on Adjusted EBITDA and EBITDA Multiples, you already speak the language buyers use to value most privately held companies. This article connects those dots and explains how buyers actually choose a valuation method and when each method is appropriate.
Further reading on Chinook’s site
- What the heck is Adjusted EBITDA (and why it matters)
- Of Course, EV = EBITDA × the Multiple… So What’s the Multiple?
- Why you should invest in a Quality of Earnings Report
- Decoding Working Capital: An Overlooked Factor in M&A Transactions
- What is the Chinook Strategic Assessment Process?
Disclaimer: Chinook does not provide tax, legal or accounting advice. This article has been published for educational purposes only.
