# How to Value a Small Business in California

> How California small businesses are valued: SDE and EBITDA multiples, asset value, fair market value vs. fair value under the Corporations Code, and appraisals.

Source: https://ridleylawoffices.com/how-to-value-a-small-business-california/

**Short answer:** Most small businesses are valued on what they earn for an owner, usually seller’s discretionary earnings or EBITDA times a multiple drawn from comparable sales, checked against the value of the assets. A buyer’s offer, a broker’s opinion, and a formal appraisal can land far apart. In California, the legal reason for the valuation also sets the standard of value, and the standard changes the number.

- Fair market value is the price between a willing buyer and a willing seller, neither under compulsion and both reasonably informed (Treas. Reg. § 20.2031-1(b)).
- A court buyout that avoids dissolution of a California corporation uses “fair value,” based on liquidation value but counting a possible going-concern sale (Corp. Code § 2000).
- A court buyout that avoids dissolution of a California LLC uses “fair market value” (Corp. Code § 17707.03).
- An ESOP must use an independent appraiser for stock that isn’t publicly traded (IRC § 401(a)(28)(C)).

Owners ask what their business is worth for very different reasons: a sale, a partner leaving, a divorce, an estate plan, a lender. The math doesn’t change much from one reason to the next. The legal standard does, and so does who has to accept the answer. This page explains the methods, shows the math on a California example, and tells you when a rule of thumb isn’t enough.

## What are the three ways to value a small business?

Appraisers use three approaches, and a careful valuation looks at more than one of them. Each answers a different question about what the business is worth.

| Approach | The question it asks | Common methods | Fits best when |
| --- | --- | --- | --- |
| Income | What will this business pay its owner in the future? | Capitalization of earnings, discounted cash flow | Steady, profitable businesses |
| Market | What have buyers paid for businesses like this one? | Multiple of SDE or EBITDA, comparable sales | Common business types with sales data, like restaurants, agencies, trades |
| Asset | What are the assets worth, less the debts? | Adjusted book value, liquidation value | Asset-heavy companies, holding companies, businesses losing money |

For most owner-run businesses selling for under a few million dollars, the market approach using seller’s discretionary earnings drives the price. The asset approach sets a floor, because nobody should sell a profitable company for less than its equipment and inventory would bring at auction.

## What is seller’s discretionary earnings (SDE)?

SDE is the total cash benefit one owner-operator takes from the business in a year. You start with net profit from the tax return or profit and loss statement and add back what a new owner wouldn’t have to pay.

- The owner’s salary and payroll taxes on it
- Personal expenses run through the business, like a family phone plan or a personal car
- One-time costs that won’t repeat, such as a lawsuit settlement or a move
- Depreciation and amortization, which aren’t cash costs
- Interest on debt the buyer won’t assume

Every add-back needs proof. A buyer, and especially a buyer’s lender, will ask for the receipts. An add-back you can’t document gets thrown out, and the price falls with it. If you’ve been running personal expenses through the business, stop a year or two before you sell so the books are clean.

EBITDA is the same idea without adding back a market-rate salary for the owner. Larger companies with a management team are usually priced on EBITDA, since the buyer will have to pay someone to run the place.

## A worked example: a Camarillo HVAC company

Dan owns an HVAC service company in Camarillo through an S corporation. Last year’s return shows net income of $180,000.

| Line | Amount |
| --- | --- |
| Net income | $180,000 |
| Add: Dan’s W-2 salary | $110,000 |
| Add: personal truck and phone | $14,000 |
| Add: one-time legal settlement | $9,000 |
| Add: depreciation | $28,000 |
| Add: interest on a loan the buyer won’t assume | $6,000 |
| **Seller’s discretionary earnings** | **$347,000** |

Now suppose the broker’s comparable sales for residential HVAC companies of this size support a multiple of 2.5 times SDE. That’s an assumption for this example, and the real multiple is what a valuation firm or broker has to justify with data. At 2.5, the market approach points to about $867,500.

Then Dan adjusts for what the multiple doesn’t see. Two technicians hold the licenses and the relationships with the biggest property management client, which is 30 percent of revenue. His lease has 18 months left. Those facts push a buyer toward a lower multiple or a price partly paid over time, like an earn-out or a seller note. A clean lease extension and a written agreement with the property manager could be worth more than any change to the add-backs.

The asset check comes last. If the trucks, tools, and parts inventory would bring $220,000 in liquidation, that’s the floor, and the gap between it and $867,500 is the goodwill a buyer is paying for.

## Which standard of value applies in California?

The same business can carry more than one legal value. Which one applies depends on why you’re valuing it. That’s the California point most valuation articles skip.

The federal tax definition is the one most people mean. Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither under any compulsion to buy or sell and both with reasonable knowledge of the relevant facts ([Treas. Reg. § 20.2031-1(b)](https://www.law.cornell.edu/cfr/text/26/20.2031-1)). Gift and estate tax valuations of business interests use it, and so do most buy-sell agreements that don’t define their own standard.

California statutes set different standards for disputes among owners.

| Situation | Standard | Authority |
| --- | --- | --- |
| Shareholders buy out a shareholder who sued to dissolve a corporation | “Fair value,” based on liquidation value but taking into account a possible sale of the whole business as a going concern | [Corp. Code § 2000](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CORP&sectionNum=2000) |
| LLC members buy out a member who sued for judicial dissolution | “Fair market value” | [Corp. Code § 17707.03](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CORP&sectionNum=17707.03) |
| A shareholder dissents from a merger or reorganization | Fair market value as of the day before the deal was announced, ignoring the deal’s effect | [Corp. Code § 1300](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CORP&sectionNum=1300) |
| Owners follow their own buy-sell agreement | Whatever the agreement says: a formula, an appraisal, or a fixed price | The agreement |

If the purchasing shareholders and the moving shareholders can’t agree on fair value, the court appoints three disinterested appraisers to appraise the fair value of the shares (Corp. Code § 2000). The LLC statute, Corp. Code § 17707.03, uses a similar three-appraiser process. A court buyout means a lawsuit is already underway, and that’s work for litigation counsel. The planning lesson is to put the valuation method in your operating agreement or buy-sell agreement now, while everyone is still getting along. See [buy-sell agreements for California businesses](https://ridleylawoffices.com/buy-sell-agreement-california/) and [business divorce and partner buyouts](https://ridleylawoffices.com/business-divorce-partner-buyout-california/).

## Do discounts apply to a minority interest?

Often, for tax and estate planning. A 20 percent interest in a family LLC is worth less than 20 percent of the company to an outside buyer, because the holder can’t control distributions or force a sale, and there’s no ready market for the interest. Appraisers apply discounts for lack of control and lack of marketability to reflect that. The size of the discount is a judgment the appraiser has to support, and the IRS can challenge it.

Discounts matter most when you’re giving interests to children or moving them into a trust. See [family limited partnerships in California](https://ridleylawoffices.com/family-limited-partnership-california/) and [family business succession](https://ridleylawoffices.com/family-business-succession-california/). In a sale of the whole company, discounts usually don’t come into it, because the buyer gets control.

## When do I need a formal appraisal?

You need one when someone other than a willing buyer has to accept the number. A broker’s opinion of value is fine for setting an asking price. A formal appraisal by a credentialed business appraiser is the norm in these situations.

- A gift or estate tax return that reports a business interest
- A sale to an ESOP, where the IRC § 401(a)(28)(C) rule requires an independent appraiser for stock that isn’t publicly traded (see [ESOPs for California business owners](https://ridleylawoffices.com/esop-california/))
- A buyout between partners or family members who don’t fully trust each other’s numbers
- A lender’s requirement, which is common in acquisition loans
- Any dispute that might end in court

I don’t prepare valuations. I work with the appraiser’s report when it goes into a buy-sell agreement, a purchase agreement, or an estate plan, and I make sure the documents use the right standard of value for the job.

## How does the value become the price?

Value is an estimate. Price is what the buyer and seller sign. Terms can move a buyer’s number more than the multiple can.

- **Cash at closing versus a note.** A seller who carries part of the price can often get a higher total, at the cost of waiting and collection risk. See [installment sales of a California business](https://ridleylawoffices.com/installment-sale-of-business-california/).
- **Earn-outs.** Part of the price depends on future results, which bridges a gap between what the seller believes and what the buyer can verify.
- **Working capital.** Whether receivables, inventory, and cash come with the business or stay with the seller changes the real price.
- **Allocation.** How the price is split among equipment, inventory, a non-compete, and goodwill changes after-tax proceeds for both sides under IRC § 1060. Take that question to your CPA.

The price and terms go into the [letter of intent](https://ridleylawoffices.com/letter-of-intent-buy-business-california/), and the buyer tests every assumption behind them in [due diligence](https://ridleylawoffices.com/due-diligence-checklist-buying-business-california/). The rest of the sale process is in [how to sell a small business in California](https://ridleylawoffices.com/how-to-sell-a-business-california/).

## Frequently asked questions

### What is the rule of thumb for valuing a small business?

Brokers often start with a multiple of SDE for owner-run businesses and a multiple of EBITDA for larger ones, with the multiple drawn from recent sales in the same industry. Rules of thumb are a starting point. They don’t account for customer concentration, a short lease, or a business that depends on the owner’s personal relationships.

### Is a business worth a multiple of revenue?

Sometimes, in industries where buyers price on revenue, such as some insurance agencies and subscription businesses. For most small businesses, profit matters more than revenue, because two companies with the same sales can earn very different amounts. A buyer’s lender will look at cash flow either way.

### Can I value my own business?

You can estimate it, and you should before you talk to buyers. An owner’s own estimate won’t carry weight with the IRS, an ESOP trustee, a court, or a skeptical partner. For those, you need an independent appraisal.

### What’s the difference between fair value and fair market value in California?

Fair market value is what a willing buyer would pay a willing seller, the federal tax definition. “Fair value” in a court buyout of a California corporation under Corp. Code § 2000 starts from liquidation value but takes into account the possibility of selling the whole business as a going concern. Which standard applies can move the number meaningfully, so the documents should name one.

### How often should I get my business valued?

Update it when the buy-sell agreement calls for it, before any gift of interests, and a year or two before you plan to sell. Many buy-sell agreements set a price once and never update it, and a stale price can force a bad buyout when an owner dies or leaves.

### Does my living trust change the value of my business?

No. Moving your shares or LLC interest into a revocable trust doesn’t change what the business is worth. It changes who can sign and manage the interest if you can’t, which is the point. See [business succession planning in California](https://ridleylawoffices.com/business-succession-planning-california/).

More in this series

- [How to sell a small business in California](https://ridleylawoffices.com/how-to-sell-a-business-california/)
- [The letter of intent to buy a California business](https://ridleylawoffices.com/letter-of-intent-buy-business-california/)
- [Due diligence checklist for buying a California business](https://ridleylawoffices.com/due-diligence-checklist-buying-business-california/)
- [ESOPs for California business owners](https://ridleylawoffices.com/esop-california/)
- [Installment sales of a California business](https://ridleylawoffices.com/installment-sale-of-business-california/)
- [All business owner guides](https://ridleylawoffices.com/business-guides/)

I draft and review buy-sell agreements, purchase agreements, and the valuation clauses in them at my hourly rate of $500. See [fees](https://ridleylawoffices.com/fees/) or my [business law](https://ridleylawoffices.com/business-law-attorney/) page.

[Talk to Eric](https://ridley.click/eric-60)

Book a consultation at [ridley.click/eric-60](https://ridley.click/eric-60) or call 805-244-5291. I work with business owners in Ventura, Santa Barbara, and Los Angeles counties by Zoom or phone.

**Please read:** This page is general information about California law as of September 2026. It isn’t legal, tax, or financial advice, and reading it doesn’t make you my client. Valuation and tax treatment depend on facts this page can’t see, so work with a qualified appraiser and your CPA as well. An attorney-client relationship starts only with a signed engagement agreement.