A Chat about Valuation

Introduction

After undergrad (real estate major), I had a four-year stint as a commercial real estate appraiser prior to med school and my foray into e-commerce and digital brokerage. So, the subject of valuation has always been of particular interest to me. Here I’ll share some insights, perspectives, and reflections on valuation and how the more familiar world of real estate bridges the less explored realm of lower middle-market digital business valuations. Hopefully, it will provide you with a better understanding of valuation and prove helpful when you’re trying to acquire or sell a digital business.

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What is Market Value?

To better understand valuation, let’s start out with the definition of market value, which is the type of value most real estate and businesses are priced, bought, and sold based upon. According to The Appraisal Institute, the definition of market value is:

“The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.” 

Market value is always expressed as an opinion, as it is a complicated combination of art and science built through data gathering and experience. Licensed or qualified appraisers provide appraisals (still with value expressed as an opinion) and brokers and non-appraisal professionals typically provide opinions of market value. There are also some other types of values such as historical value, liquidation value, or assessment value that appraisers often provide. Notice above that the definition of market value does not mention nor vary based on financial buyer vs strategic buyer.  

“The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.”

The Appraisal Institute

Sometimes I come across business owners telling me that they only want to sell to a “strategic buyer”. What this translates to is that they don’t want to sell at market value, and like many business owners, think their company is more valuable than it really is. If every company could sell their business to the almost-mythical strategic buyer at five times market value, why would anyone sell at market value? I don’t have the data, but I’m guessing strategic acquisitions significantly above market value in the micro and lower middle market occur in much less than 1% of the acquisitions. That is a conversation for another time, but the value a company has to a strategic buyer is individualistic to that company and damn near impossible for an appraiser to determine if they don’t have detailed insight into the buyer’s company and strategy. So, let’s just table that type of value for now and focus on market value, the price at which most of you will typically buy or sell a company. 

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What is an Appraisal?

The definition of appraisal according to the American Society of Appraisers is simply “ The act or process of developing an opinion of value”. This does not mean that anyone can charge for their opinion of value and call it an appraisal. There are state licensure laws and accrediting bodies that tightly regulate who can call themselves a professional appraiser, receive payment for an “appraisal” and how an appraisal must be created and presented. The institutions ordering appraisals also have standards regarding who they will allow to perform an appraisal. So, most companies listed for sale have not undergone an appraisal, and won’t ever undergo an appraisal, unless the capital provided for their acquisition is being funded by a banking institution.

In a very simplified explanation, an appraisal coming from a licensed or accredited appraiser consists of the appraiser defining the assignment, collecting subject data along with market and economic data, using one or more approved approaches to determine a value, reconciling that value and then providing an opinion of value. 

So, if most companies listed for sale are not appraised, do asking prices have any merit? The answer is sometimes. If a company is listed for sale by the owner, that owner can ask whatever they want for their business. They could be a professional appraiser and have the market value spot on or they could be selling a company for the first time and have absolutely no idea how to value a company. If a company is listed for sale by a broker or M&A professional, as previously mentioned above, they will provide an opinion of value to the seller. That does not necessarily mean that the broker will always be precise in their estimates, but they will likely be much more accurate than the person selling their own business with zero experience. 

Furthermore, just because a business is represented by a broker and an accurate opinion of value was provided does not mean that the client who owns the business will heed the advice of their broker. Most owners seem to think their business is special and worth more than market value, or they just aren’t educated on valuation and heard that some VC-backed company sold for 20X revenue and thinks that’s how their company should be valued. That, or they just don’t want to sell the company for a price that the market is willing to pay, which is, of course, their prerogative. Keep in mind, as with most assets being offered for sale, sellers and sales professionals usually take into consideration negotiating buyers and add a little wiggle room built in to the price. 

Approaches to Value

The number one question I’m asked by buyers in regard to the listing price of a business is “How did you arrive at the asking price?”. I bet real estate agents don’t get asked that question on every listing they have, but I do. That’s because valuing digital companies in the micro-market/main street market (under $5M in revenue) to lower middle market (around $5M to $50M-$100M in revenue) value range is much less understood and structured than the valuation of real estate, which many more people are familiar with. Because many Americans own homes, and most homeowners utilize a bank loan to acquire their house, many readers will be familiar with the appraisal process of valuing a home, which is typically performed using a sales comparison approach (market approach in business valuation). The widespread use of real estate websites and apps such asZillow.comalso exposes the sales comparison approach to the public eye. 

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The sales comparison approach involves a state-licensed residential real estate appraiser identifying houses that are comparable in location, age, condition, size, style, construction, and other popular features to the subject home that have sold in the same area, or similar neighborhoods, and in recent history. They then adjust the comparables (comps) up or down according to their relative variability from the subject house. In the US, the sale of houses is public record and all sales pricing is available to anyone, making the process of using sales comparables very easy and reliable, with a huge and up-to-date database to choose from. The same goes for commercial properties, and these commercial sales comps are used both for the sales comparison approach and to extract cap rates and multipliers to use in the income approach.  

In stark contrast, most private business sales in the main street to lower middle market arena are confidential and the details never see the light of day. Note, the business terms “main street” and “lower middle market” are often interchangeable with the term small and medium-sized businesses (SMBs), which you’ll often see mentioned on social media such as Twitter and Linkedin. Most US states don’t even have licensing for business brokers or business appraisers and there are very few local MLS (multiple listing services) from which to find comparable sales. Those that do exist have almost no data on digital businesses. This makes the process of building an opinion of market value much different (and perhaps much less accurate and reliable) for the business owner or broker. Digital business brokers primarily rely on internal comps and what they’re seeing on a day-to-day basis in the market by speaking to buyers and sellers. If you’re a seller, it would serve you well to highlight all the qualities and opportunities that make your business valuable, in addition to providing information on the potential buyers and their motivations for acquiring your company. If you’re a buyer, this lack of information creates an imperfect marketplace and thus an opportunity to buy businesses at a deal. 

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For income producing businesses and properties (primarily commercial/industrial properties or portfolios of residential homes), a valuation is most heavily weighted on the income capitalization approach. Income-producing businesses and real estate are typically acquired as investments, with their earning potential being the primary factor influencing value from an investor's standpoint. When employing the income capitalization approach, value is gauged as the present value of the future expected earnings derived from the business or property ownership. This method consists of two distinct approaches: direct capitalization and yield capitalization.

In direct capitalization, the value is derived by applying either a capitalization rate (cap rate) or an income multiplier, both typically gained from comparable sales, to a single year's income. If a property’s net operating income is $100K, you simply divide that by the selected cap rate to derive the value. For example, if the cap rate selected was 6%, the value would be equated at $1.66M ($100K/0.06). When valuing companies, the market typically uses a multiplier instead, applied to the company’s EBITDA (earnings before interest, taxes, depreciation, and amortization) or SDE (seller’s discretionary earnings), both about equivalent to real estate’s NOI (net operating income). A company making $100K EBITDA/SDE with a selected multiplier of 3 would equate to a value of $300K. By the way, this is equivalent to a 33% cap rate, and why I have so many clients coming from the real estate world to acquire businesses with me. 

Author’s note: at the time of writing, a 6% cap rate would be reasonable for a commercial property in Tampa with $100K NOI, and a 3 multiple would be reasonable for a company with $100K SDE (seller’s discretionary earnings), depending on many variables of course. 

In contrast, yield capitalization relies on several years of income and the reversionary value (selling price) expected at the end of a specified period. Yield capitalization is most commonly performed using a discounted cash flow analysis, where the person valuing the property projects earnings and expenses for several periods (usually 10 years) using market and subject property data. The estimated selling price is also factored in and then the total expected future earnings are discounted using the selected yield/discount rate to arrive at a present value. This method is not used very often in sub-$50M companies due to the complexity involved in estimating future earnings and expenses across a highly dynamic economy. The direct capitalization method is typically preferred for stable properties or companies while the yield capitalization is often selected for cases where there are more variances such as expected vacancy stabilization or rapid company growth. 

There is one more primary approach to value- the cost/asset approach. In real estate, the cost approach is often used in appraisals. The asset approach is sometimes used in business appraisals, but doesn’t make any sense in digital companies because there often are no hard assets, and is thus never applied. However, prior to purchasing a company, many sophisticated buyers will ask themselves if they can build what they want cheaper, more efficiently and effectively than they can buy it for. Amazon did this when they wanted a shoe company. Having had the experience of building Amazon, they thought they could build a retail shoe company and first launchedEndless.comin 2007. However, when that failed, they acquiredZappos.comfor $928 million in 2009. Amazon’s failure says a lot about buying a company over building one. 

Multiple Selection

In both income capitalization methods, selecting the appropriate capitalization rate, or yield/discount rate for real estate may sometimes be difficult due to property and market variability, risk assessment, data quality, dynamic economic states, etc. The same can be said when these methods are applied to businesses. As previously mentioned, the main hurdle in multiple selection for small digital businesses is the lack of comparable sales. Many private sellers either pick a value out of thin air that they want for their business or use a multiple they heard one of their friends sold a company for. Most brokers use their own internal comps and the live feedback they’re receiving from the market for multiplier selection. Because companies are so dynamic, it’s uncommon to have a group of very similar and recent comparables from which to extract a solid multiplier. So, often an adjustment and estimation is necessary. 

Generally speaking, the market identifies certain traits of a business to be less inherently risky, making the company more valuable. After all, expectations of future earnings consist of both earnings and the probability of actually receiving those earnings. Business qualities such as diversity of revenue channels and customers, number of SKUs, revenue per SKU, longevity of the business, expertise of the staff, churn rate, recurring revenue, profit margins, profit stability, growth, total profit amount, and many others are rewarded and positive checkmarks in any of those categories (and more) can increase the multiple that is selected and applied to the cash flow, thus raising the value of the company.   

What about SaaS?

Software-as-a-Service (SaaS) companies, like Shopify or Salesforce, offer subscription-based software and can be attractive due to their recurring revenue and growth potential. However, they come with complexities that new buyers should approach with caution. When valuing a SaaS business, buyers typically focus on Annual Recurring Revenue (ARR)—the predictable revenue from subscriptions over a year—and apply a multiple to estimate its worth. According to SaaS Capital’s 2025 analysis, the median ARR multiple for private SaaS companies with $5M to $15M in ARR was 4.8X to 5.3X, meaning a SaaS company with $5M ARR might be valued at $25M. This multiple varies based on performance: companies growing faster than 40% annually can see multiples closer to 6X or higher, while those growing slower than 10% might be valued around 4X. Profitability also matters—SaaS companies with positive EBITDA margins (e.g., 10% or higher) often command higher multiples, as they show financial stability, whereas unprofitable ones carry more risk.

Warning for Beginners: While SaaS businesses can seem appealing, non-profitable SaaS and software companies are generally not recommended as acquisition targets for new buyers. Many early-stage SaaS companies prioritize growth over profitability, often operating at a loss to gain market share. This can lead to cash flow challenges, high customer churn, or significant operating costs that are hard to manage without experience. For instance, a SaaS company might have $5M ARR but lose money due to high marketing expenses, making it a risky investment for a beginner (not to mention next to impossible to obtain lending on). Instead, focus on smaller profitable SaaS companies that are easier to understand and manage. As you gain experience, you can explore SaaS acquisitions with a better grasp of their risks and rewards.

Putting it All Together

Now that we’ve covered what market value means, the difference between an appraisal and an opinion of value and how to arrive at a market value, let’s try to make some sense of it and apply it to a digital business. 

Even though the digital SMB industry doesn’t have the same access to reliable and plentiful data from which to extract sales comparables and multipliers, an exit at market value is still usually achieved through the sales process. Remember that definition of market value mentioned earlier that included this phrase: “...for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale…”? The entire fundamental purpose of determining market value is to ascertain what price the business would sell for in an open and fair market. Well, the most obvious and accurate way of doing that is to simply offer the business for sale in the open market for a reasonable amount of time and see what the company sells for. This doesn’t necessarily mean that listing a business for six months will yield the absolute highest price that anyone would ever pay, but that is not the definition of market value and not a realistic goal when selling an asset. 

Since buyers are not typically going to offer more money than is being asked for, the prudent procedure to achieve market value in a transaction is for the business owner and/or broker to list the company for more than what their estimate of market value is and see where the offers come in. This is why, from my experience, asking prices on companies represented by a broker are often accurate within about 1 multiple, but are heavily skewed to the higher end of the range, and as you can see, this makes perfect sense. Of course, the seller of the company still has the final say when selecting a price at which a company is listed for sale. So, sometimes a seller just isn’t willing to listen to their advisor and the list price is far above market value for the company. This occurs in real estate too, but when a broker can show their client ten recent and accurate comps in the area, it’s much easier to convince the homeowner of a realistic market value. 

Funding

One last thing I want to discuss is funding and interest rates. This is currently having a dramatic impact in the acquisition space and on the economy in general. It is not a consideration that applies directly to the selection of a multiplier and the equating of market value, (though it can be a consideration of discount rate selection in yield capitalization) but it is an externality that influences what the buyers who comprise the market can afford to pay for companies and can indirectly affect market values. 

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Consider purchasing a $1M company with a 10% equity injection ($100K), borrowing $900K and paying a 7% interest rate over 10 years (common SBA backed-loan in 2021). The total interest paid over the life of the loan would be $353,972 with monthly payments of $10,450. This brings the total amount paid for the company to $1,353,972.

The same company at an 11% interest rate would be paying $587,700 total interest over the life of the loan with monthly payments of $12,398. This brings the total amount paid for the company to $1,487,700. This change in interest rates makes this same company $233,728, or 17.3% more expensive, if using the most common source of institutional lending in the US to acquire companies- SBA-backed loans. It also provides $1,948, or 18.6% less per month in cash flow to the buyer.

Now, a fluctuation in interest rates does not change the value that the business provides to the economy or its clients, and it doesn’t inherently change the current value of the expected future financial benefits, but it does have an effect on how much cash is going into the buyer’s pockets if they are using a loan to acquire it. Since the majority of the US market does utilize loans to fund acquisitions in the $500K to $5M space, an increase in interest rates lowers the price many buyers can afford to pay for companies due to the cash flow of the business not being able to cover the monthly debt service owed to the lender. A large part of this is due to the fact that buyers in the US have an amazing SBA program and have long been able to purchase companies with a 10% down payment. If the market was used to putting 30% cash down when buying a company, this wouldn’t place such a heavy downward pressure on the market. 

Conclusion

Valuing a digital company doesn’t have to be overly complicated. Every person I speak to values a company differently, and most of the time it looks something like this: “I like the business, it fits my criteria and I’ll see if I can negotiate the price down and get it approved for lending.” That’s actually perfectly acceptable and how a large majority of the individual buyer SMB market works. It works because most businesses are offered for sale within a pretty small multiple range for that type and size of business at that specific time. Plus, most buyers utilize an SBA-backed loan and the banks have debt service coverage ratios limiting how much they will lend on a company and thus how much a buyer can pay for the company.  Whether it takes a buyer two years or two-and-a-half years to realize a return on their investment probably doesn’t change much in the grand scheme of things for the typical buyer. The more important thing is that you actually get out there and buy a good business.