A retired client of mine, Raymond, 68, who'd spent thirty-one years building a commercial HVAC company in Waterbury, sat across from me last spring with the offer letter from a regional buyer in his hand. He'd done $2.1 million in revenue the year before, the business threw off about $480,000 in seller's discretionary earnings, and he assumed that meant a price somewhere north of $2 million. The letter offered $1.35 million, with $400,000 of it held back in an earn-out tied to the next three years of performance. Raymond looked at me and said, "Ben, I thought thirty years of work was worth more than this."
It was. And it wasn't. That's the conversation this column is really about, because most small business owners I've worked with over the last 35 years have had some version of Raymond's morning. They walk in expecting one number and the market hands them another, and the gap between those two numbers is usually the cost of not understanding how a business is valued, how a sale is structured, and how much of the proceeds the IRS quietly takes home.
If you own a small business and you're thinking about an exit in the next three to five years, here's what I wish more sellers knew before the first broker call.
What Your Business Is Actually Worth
There are three valuation methods that matter for businesses under $5 million in revenue, and most of the online calculators get them wrong.
The first is asset-based valuation: what your tangible and intangible assets are worth if the business stopped operating tomorrow. Equipment, inventory, receivables, real estate, minus your liabilities. This is the floor. For a service business with no inventory and a leased space, it's usually a sad number. For a manufacturing shop with $400,000 in CNC equipment and a paid-off building, it can be substantial.
The second, and the one that matters most for small businesses, is the earnings multiple applied to Seller's Discretionary Earnings (SDE). SDE is your net profit plus the owner's salary, plus any personal expenses the business has been carrying, plus depreciation, interest, and taxes. It's the number that tells a buyer what the business actually produced for you. According to recent BizBuySell quarterly reports, small service businesses typically sell for 2 to 3 times SDE. Manufacturing and distribution businesses run 3 to 5 times. E-commerce and SaaS, where revenue is recurring and predictable, can go higher; sometimes 1 to 3 times annual revenue for SaaS, though the multiples have compressed since 2022.
The third is discounted cash flow (DCF), which projects future earnings and discounts them back to a present value. For sub-$5 million businesses, DCF is rarely used. Buyers at this level want to see what you've actually earned, not a projection. If a broker is selling you a DCF-based valuation for a small business, ask why.
Raymond's HVAC company at 2.5 times SDE came out to $1.2 million on the bare numbers. The buyer's offer of $1.35 million was, in fact, slightly above market, once you accounted for the earn-out structure that shifted some of the risk back to Raymond. He thought he was being lowballed. He wasn't.
If you want a serious valuation before you talk to a broker, the BizBuySell valuation tool is a free starting point, but pay a certified business appraiser ($3,500 to $7,000 for a small business) before you take an offer seriously. The number you get will pay for itself in negotiating leverage.
Asset Sale vs. Stock Sale: The Fight You'll Have With Your Buyer
This is the most consequential decision in the transaction, and it's the one most sellers don't understand until their accountant explains it three weeks before closing.
In an asset sale, the buyer purchases specific assets (equipment, inventory, customer lists, the trade name) but not the legal entity. Your old corporation or LLC continues to exist (you wind it down later), and you keep its liabilities. Buyers prefer this because they get a stepped-up basis on the assets, meaning they can depreciate them again, and they're not inheriting your tax history or any unknown legal exposures.
In a stock sale, the buyer purchases the legal entity itself: all the shares of the corporation. They get the assets, the liabilities, the tax history, the contracts, the employees, all of it. Sellers prefer this because the proceeds are usually taxed at long-term capital gains rates (currently 15% or 20% depending on your bracket, plus the 3.8% net investment income tax), rather than the mix of ordinary income and capital gains you get in an asset sale.
The difference can be enormous. On a $1.5 million sale, the tax bill can vary by $150,000 or more depending on how the price is allocated across asset classes. The IRS requires both sides to file Form 8594 with matching allocations, so you have to agree, but the negotiation over that allocation is real money.
If your company is organized as a C-corporation and you've held the stock for more than five years, ask your CPA about Qualified Small Business Stock under Section 1202. For qualifying companies, up to 100% of the gain on the sale of QSBS (capped at $10 million or 10 times your basis, whichever is greater) can be excluded from federal capital gains tax. This is not theoretical. It's one of the most generous provisions in the tax code, and it's chronically underused because most owners of pass-through entities (S-corps, LLCs) don't qualify and most C-corp owners don't know about it. Rules expanded in 2025 under the OBBBA for stock issued after July 4, 2025 — verify the current cap and hold-period tiers with your tax advisor before relying on the older $10 million / five-year numbers.
The Three Exit Paths, Honestly Ranked
Most owners imagine one of three buyers when they think about exit: a third party, their employees, or their kids. The reality of how each one works is different than the romance.
Third-party sale. For businesses with SDE under $5 million, you're working with a business broker (IBBA-certified ideally), not an investment bank. The good ones take 8 to 12% commission and run a real process: blind teaser, confidentiality agreements, buyer vetting, multiple offers, Letter of Intent, due diligence, definitive agreement. Total timeline: 6 to 12 months. For businesses between $5 million and $50 million in enterprise value, you graduate to a lower-middle-market M&A advisor or boutique investment bank, and the process tightens up considerably. The Axial platform is the standard tool advisors use to reach institutional buyers.
Sale to employees. Everyone romanticizes the Employee Stock Ownership Plan. For most businesses under $10 million, an ESOP is impractical. The setup costs run $80,000 to $150,000, ongoing administration is $25,000 to $50,000 per year, and you need enough cash flow to service the leveraged debt. What works more often is a direct buyout by one or two key employees, financed with a combination of SBA 7(a) loans (up to $5 million) and seller financing. The seller usually carries 20 to 30% of the purchase price on a note over 5 to 7 years. This is the path Raymond ended up taking, after the third-party offer didn't work out. His operations manager and lead service tech bought the company together with an SBA loan.
Family transfer. This is the one I have the longest conversations about, because the math is easier than the family dynamics. The 2026 federal lifetime gift and estate tax exemption sits at the current threshold. Congress acted in 2025 to address the TCJA sunset, but the specifics keep moving, so verify the current number with your CPA before structuring anything. Several states (including New York, Massachusetts, and Connecticut) have their own estate taxes with much lower thresholds, often around $2 million to $7 million. You can transfer ownership via gifts, sales to grantor trusts, or installment notes, each with different tax consequences. The harder problem is rarely tax. It's whether the next generation actually wants the business, whether they're competent to run it, and how you treat the kids who aren't involved. Tom Deans's book Every Family's Business is one of the few honest treatments of this. He argues, controversially, that selling to outsiders and dividing the cash is often fairer to a family than handing the business to one child.
The Six-Month Timeline
If you're starting from scratch and your business is reasonably clean, here's a realistic timeline.
- Months 1-2: Get the financials buyer-ready. Three years of clean, accountant-prepared financial statements. Separate personal expenses from business expenses. Resolve any commingling. If you've been running your car, your phone, and your country club through the business, document those add-backs precisely for SDE calculation.
- Months 2-3: Get a real valuation. Certified business appraiser, not a broker's pitch deck. Understand your floor, your market value, and your stretch number.
- Months 3-4: Engage your team. A business broker or M&A advisor, a CPA who has actually done sale transactions (not just tax returns), and an attorney who has handled at least a dozen small business sales. The cheapest professional team will cost you more than the most expensive.
- Months 4-6: Run the marketing and negotiation process. Confidential listing, buyer outreach, Letters of Intent, selection of the buyer.
- Months 6-9: Due diligence and definitive agreement. This is where deals die. The buyer's diligence will surface things you forgot about: a customer concentration issue, an employee classification problem, an old lease assignment. Expect retrades. Plan for them.
- Months 9-12: Closing and transition. Most deals include a transition period where the seller stays on for 60 to 180 days. Negotiate this carefully. Your buyer wants your help; you want to be paid fairly for it.
What to Read and Who to Call
The SBA's selling-your-business resources are the best free starting point. IRS Publication 544 (Sales and Other Dispositions of Assets) is the dry but essential read on how the gain gets calculated and reported. SCORE, the volunteer mentor program, has retired business owners who've actually done this; the consultations are free, and the value is real. For the family-transfer scenario specifically, Tom Deans's Every Family's Business is worth the cover price.
For the planning piece that sits behind the sale, our guides on estate planning fundamentals and the retirement-age decision cover how the sale proceeds interact with the rest of your financial picture.
A Realistic Closing Thought
Raymond closed with his operations manager and lead tech eight months after that first disappointing offer. He carried a $300,000 note at 7% interest over six years, took $850,000 at close, and stayed on as a consultant two days a week for the first year at $1,500 a day. The total came out about where the third-party offer had been. But he handed the business to two people he'd trained for two decades, he gets a check every month that funds Maggie's idea of a real retirement, and he doesn't drive past the building wondering if the new owner laid off Eddie in the parts department.
The right exit isn't always the highest number. But you can't make that call until you actually know what the highest number is. Start with the valuation. The rest follows.
