Small Business M&A: Valuation, Quality of Earnings & Tax

Small businesses under $10M are typically valued using a multiple of either SDE (Seller's Discretionary Earnings) for owner-operator deals under $1M to $2M, or normalized EBITDA for larger deals. Reports apply the income, market, and asset approaches under SSVS, then triangulate against actual transaction multiples in your industry. SDE multiples typically run 2 to 4x; EBITDA multiples 3 to 7x depending on growth, customer concentration, and recurring revenue.

A QoE report is a buyer-focused financial analysis that validates the seller's reported earnings, identifies one-time and non-recurring items, normalizes owner compensation, and produces a defensible run-rate EBITDA or SDE. It is the financial spine of due diligence and almost always the basis for SBA lender approval on small business acquisitions. QoE differs from an audit in scope and purpose — it is forward-looking and transaction-specific.

SDE (Seller's Discretionary Earnings) adds back the full owner's compensation, benefits, and discretionary expenses to operating profit, and is used for owner-operator deals where the buyer will replace the seller. EBITDA only adds back interest, taxes, depreciation, and amortization, and is used when the business will keep professional management post-close. SDE typically commands 2 to 4x; EBITDA 3 to 7x. Choosing the right metric materially changes the headline price.

Buyers prefer asset deals (basis step-up, no historical liability assumption). Sellers prefer stock deals (capital gains rate, no recapture, no double tax for C-Corps). The Section 338(h)(10) election lets both sides treat a stock purchase as a deemed asset sale, often bridging the gap. We model after-tax cash to seller across all paths so you decide based on the actual number, not the structure label.

A Section 338(h)(10) election is a joint buyer-seller election on a stock deal that treats it as a deemed asset sale, giving the buyer step-up basis. An F-reorganization (Section 368(a)(1)(F)) is a pre-sale restructuring (typically dropping the S-Corp into a new holding company) that lets the buyer acquire the LLC subsidiary in a clean asset deal without the seller losing S-Corp benefits. F-reorgs are the dominant small-deal structure for S-Corp targets.

For sub-$10M deals, financial and tax due diligence typically runs 3 to 6 weeks from data room access to final report. SBA-financed deals run on the lender's clock and add another 2 to 4 weeks for underwriting review. We usually start QoE field work in parallel with the LOI exclusivity period to keep the close on schedule.

The biggest levers are deal structure (asset vs stock vs 338(h)(10) vs F-reorg), entity structure pre-sale (Section 1202 QSBS qualification for C-Corp founders), installment sale election under Section 453, rollover equity treatment, and timing of the close around quarterly estimates. Most of these have to be locked in 12 to 36 months pre-sale, which is why exit planning starts long before the LOI.

The working capital peg is the target level of working capital (typically a trailing 12-month average) that the seller must deliver at close. Anything above the peg increases the purchase price; anything below decreases it. Most sub-$10M sellers leave money on the table by under-negotiating the peg. We calculate the peg from financials, model normalized vs delivered working capital, and run the post-close true-up.