Business Valuation Methods: DCF, Comparable Companies, SDE Multiples, and 409A Valuations

A valuation is an opinion with arithmetic attached, and the opinion lives in a handful of inputs. In this guide, a discounted cash flow model built from a 10-year Treasury yield of 5.24% and a published equity risk premium of 4.23% gives an enterprise value of $86.4 million. Move the discount rate by one percentage point and it becomes $73.3 million. Move terminal growth by one point and it becomes $100.8 million.

This post explains how each of the main methods works, builds one DCF in full so you can see where the sensitivity comes from, shows why a small-business sale is priced differently from a listed company, and covers the IRS rules for valuing startup stock options. Our capital allocation guide covers what to do with a valuation once you have it, our acquirer's guide to M&A covers how much of a premium a buyer can justify, and the succession planning guide covers valuations for a handover. Nothing here is valuation, tax, or legal advice.

Which method fits which situation

Discounted cash flow

A DCF forecasts unlevered free cash flow, which is operating profit after tax plus depreciation, minus capital spending and investment in working capital. It discounts those cash flows, plus a terminal value for everything after the forecast, at the weighted average cost of capital (WACC). The result is enterprise value. Subtracting net debt gives equity value.

Building the discount rate

WACC has two pieces. The cost of equity is the risk-free rate plus beta times the equity risk premium (ERP). The cost of debt is what the company pays to borrow, reduced by the tax shield.

• Risk-free rate: the 10-year Treasury constant maturity yield was 5.24% on September 28, 2026 on FRED.
• Equity risk premium: Aswath Damodaran's implied ERP was 4.23% at the start of 2026. He recomputes it monthly, so check his current figure before using it. He also nets a US default spread out of the Treasury yield to get his risk-free rate, following the Moody's downgrade of the US, so his risk-free rate is a little lower than the raw yield used here.
• Beta 1.10, a pre-tax borrowing spread of 2.50 points over the Treasury, and a 25% tax rate are assumptions chosen for this example.

With a 70/30 equity-to-debt mix, the cost of equity is 5.24% + 1.10 x 4.23% = 9.89%. The after-tax cost of debt is (5.24% + 2.50%) x 0.75 = 5.81%. WACC is 0.70 x 9.89% + 0.30 x 5.81% = 8.67%.

Illustration: a $40 million services company

The company has revenue of $40 million, an operating margin of 15%, depreciation of 3% of revenue, capital spending of 3.5% of revenue, working capital equal to 10% of any revenue increase, and $15 million of net debt. Revenue grows 8%, 7%, 6%, 5%, and 4% over five years, and 3% a year after that. All figures are in millions of dollars and come from a script we ran and checked.

The five discounted cash flows sum to $19.3 million. The terminal value is year-6 free cash flow of $5.76 million divided by (8.67% - 3.00%), which is $101.7 million, or $67.1 million after discounting five years. Enterprise value is $86.4 million, and equity value is $71.4 million after net debt.

Terminal value is 78% of the total. That is normal for a DCF and it is the first thing to check. The terminal value here implies about 10.3 times year-6 EBITDA. If your terminal multiple implies something far from what comparable companies trade at, the growth and discount-rate inputs are carrying an assumption you have not looked at.

Sensitivity

Enterprise value in millions of dollars, by WACC (rows) and terminal growth (columns):

The corners are $63.3 million and $134.7 million on the same forecast. The inputs behind WACC matter as much as the two axes. A beta of 0.8 gives a WACC of 7.78% and an enterprise value of $102.7 million, while a beta of 1.4 gives 9.55% and $74.5 million. An ERP of 5.0% in place of 4.23% lifts WACC to 9.26% and cuts value to $78.1 million.

Practical rules that follow:

1. Show the table, not a point estimate. A single number invites a negotiation over the inputs, while a table shows what the two parties disagree about.
2. Keep terminal growth below the long-run growth of the economy and well below the risk-free rate. The 3% used here sits under a 5.24% Treasury yield.
3. Forecast cash flows and the discount rate in the same terms. Nominal cash flows take a nominal WACC.
4. Do not fix a disagreement by stretching the forecast period. A ten-year forecast just moves the guesswork later.

Trading comps and precedent transactions

The market approach applies a multiple observed elsewhere to your company's earnings.

Trading comps use listed peers. Damodaran's January 2026 sector data shows the US market's EV/EBITDA multiples for firms with positive EBITDA at 19.73 for the whole market, 16.22 for machinery, and 14.26 for business and consumer services. Applied to our illustration's $7.2 million of EBITDA, the services multiple gives $102.7 million, against the DCF's $86.4 million, which is 12.0 times. The gap has explanations worth naming: listed companies are larger, more liquid, and often faster growing, and multiples across a whole sector are averages that include firms with very different growth.

Precedent transactions use prices paid for whole companies, so they include whatever premium buyers paid for control and synergies. They suit a sale but overstate what a minority stake is worth. Sources include paid transaction databases and public merger proxies, which disclose the bankers' comparable deals. For premiums, the Goldman Sachs analysis in Electronic Arts' 2025 merger proxy found a 32% median premium across 179 all-cash US public deals of $5 billion or more from July 2015 to September 2025 (25th percentile 20%, 75th percentile 51%). Whether a buyer can afford to pay it depends on synergies, which the M&A guide works through.

Small businesses: seller's discretionary earnings

Main street businesses are priced on seller's discretionary earnings (SDE): pre-tax profit plus one owner's salary and perks, interest, depreciation, and one-time costs. BizBuySell's industry multiples page states that its cash flow multiples are SDE divided by sale price.

In BizBuySell's Q2 2026 Insight Report, 2,117 businesses changed hands. The median sale price was $349,250, median cash flow was $155,921, and the average cash flow multiple was 2.7 (average revenue multiple 0.7). Compare that 2.7 with 14.26 for listed business services and you can see why a listed-company multiple should never be applied to a shop with one owner. The difference reflects size, key-person dependence, and how hard the shares are to sell.

Illustration: a business with $110,000 of pre-tax profit pays its owner $90,000, runs $15,000 of personal expenses through the company, and reports $12,000 of depreciation, $8,000 of interest, and a $5,000 one-time legal cost. SDE is $240,000. At 2.7 times, the price is $648,000, and at 2.5 times it is $600,000. A buyer who plans to hire a manager for $95,000 sees only $145,000 of earnings left for the owner's seat, so a smart buyer discounts an SDE-based offer when they will not work in the business. This is why an asking price built from SDE should be checked against a version with a market-rate manager, and why many mid-size deals move to EBITDA.

Discounts and premiums for control and marketability

Two adjustments recur in private-company appraisals. A discount for lack of marketability (DLOM) reduces value because private shares cannot be sold quickly. A discount for lack of control (DLOC) reduces the value of a minority stake because the holder cannot direct the company, and a control premium works in the other direction.

Treasury Regulation 1.409A-1 itself lists "control premiums or discounts for lack of marketability" among the relevant factors, so these adjustments are standard practice, but the regulation gives no percentage. Appraisers derive the number from restricted-stock studies, pre-IPO studies, and option-pricing models, and it moves with the facts, so any single range quoted in an article should be treated with suspicion. What you can do without the studies is see the arithmetic. A 20% DLOM on our $71.4 million equity value gives $57.1 million, and a 30% DLOM gives $50.0 million.

The premium works in reverse. A price that includes a 32% premium means the unaffected value was about 24% lower than the deal price (1 divided by 1.32 is 0.758). Applying that median to a private company would be a mistake, since it comes from large listed targets. The right use is to see which side of the line a number sits on: a DCF of a whole company is a control value, and a quote from a secondary marketplace for a few shares is a minority, non-marketable value.

409A valuations for startups

Section 409A applies when a company grants stock options. If the strike price is below the fair market value of the common stock on the grant date, the option can be deferred compensation subject to penalty taxes on the holder, including a 20% additional tax under 26 U.S.C. 409A. The regulation at 1.409A-1(b)(5)(iv) protects valuations that use one of three methods. The IRS may rebut a presumption only by showing the method or its application was grossly unreasonable.

1. An independent appraisal that meets the requirements of section 401(a)(28)(C), as of a date no more than 12 months before the grant.
2. A formula valuation used consistently for all transfers, of the type used in a nonlapse restriction.
3. A written valuation, made reasonably and in good faith, of illiquid stock of a start-up. The company must have no trade or business conducted for 10 years or more and no publicly traded equity, and the stock must carry no put or call rights, other than certain rights of first refusal. The valuation must be done by someone qualified, which the regulation generally reads as at least five years of relevant experience in business valuation, accounting, investment banking, private equity, secured lending, or a comparable field.

Two limits in the text matter. A valuation is not reasonable if it ignores later information that materially affects value (the regulation's examples are resolving major litigation or issuing a patent) or if it is more than 12 months old. And the start-up method is unavailable if the company reasonably expects a change in control within 90 days or a public offering within 180 days after the action being valued. Our reading is that a new priced financing is the clearest example of later information, so companies commonly refresh the valuation after each round, but the regulation does not say that.

A 409A value is for common stock, so it sits below the price investors pay for preferred stock, which carries liquidation preferences. The pre-IPO guide shows a preference stack in numbers, and the venture capital guide covers the terms behind it. Convertible notes and SAFEs convert on cap or discount terms, covered in the convertible debt guide.

Enterprise value and equity value

Enterprise value is equity value plus debt, preferred stock, and non-controlling interests, minus cash. Use enterprise value with EBITDA and other multiples measured before interest, since those earnings belong to all capital providers, and use equity value with net income and per-share measures. The common mistake is mixing them, for example dividing equity value by EBITDA. In the illustration, $86.4 million of enterprise value less $15 million of net debt is $71.4 million of equity, and comparing that $71.4 million to EBITDA would understate the multiple.

Lenders and buyers also look at how the price will be financed. See the debt capacity guide and the M&A due diligence guide for how a quality-of-earnings review changes the earnings you are multiplying.

Before you rely on a number

1. State what standard of value applies: whole-company control, marketable minority, or non-marketable minority. The same business has different values under each.
2. Rebuild the earnings base first. Adjust for one-time items and owner pay before applying any multiple.
3. Show a sensitivity table and say which input drives it.
4. Cross-check the DCF's terminal multiple against comparable companies.
5. For option grants, get a written appraisal from a qualified provider and file it with the grant records.
6. For a sale, use a broker or valuation professional who has closed deals in your size band.

This guide is for informational purposes only. Business valuation involves tax rules, accounting standards, and judgment. Consult a qualified valuation professional and a CPA or tax attorney.