Most sellers set their asking price by working backward from a number they heard at a golf outing. Most searchers build their first LOI around a multiple they read on a forum. Neither approach ends well.
Valuation in a search fund acquisition is a process. Like every serious process, it has rules, and the rules exist because someone got burned before you.
Here is how it actually works.
The starting point: EBITDA, not revenue
Search funds buy cash flow, not potential. Revenue is a vanity metric. EBITDA (earnings before interest, taxes, depreciation, and amortization) is what funds the debt service, pays the operator, and determines what you can afford to pay.
According to the Stanford 2024 Search Fund Study, the median acquisition target generates $2.2 million in EBITDA and sells for $14.4 million, a 7.0x EBITDA multiple. That 7.0x is your baseline. Everything from there is an adjustment.
The IBBA Q4 2024 Market Pulse Report documents multiples across deal sizes. Businesses with $1M-$2M SDE (seller's discretionary earnings) transact between 2.4x and 3.5x SDE. Businesses in the $5M-$50M purchase price range command 3.8x-5.0x EBITDA on average. The premium for scale is real and consistent.
Smaller deals carry more risk: key-person dependence, fewer systems, thinner management benches. The market prices that risk into the multiple.
What moves the multiple up or down
Five factors drive valuation away from the median. Know each before you build a model.
Quality of earnings. QoE is not an audit. It is a reconstruction of what EBITDA actually is after removing owner perks, one-time items, and accounting choices that inflate margin. Adjustments of 15% to 40% to reported EBITDA are normal. A business reporting $2M EBITDA might have $1.4M of actual repeatable earnings once the seller's personal car, family payroll, and one-time customers get stripped out. The QoE determines your real purchase price, not the seller's stated number.
Revenue quality. Recurring revenue earns a premium. Contracted SaaS or subscription revenue with high retention might justify 9x-10x EBITDA. Project-based or one-time revenue earns 5x-6x at best. The difference between "we invoice monthly" and "customers have multi-year auto-renewal contracts" can represent 2x-3x turns of multiple.
Customer concentration. If one customer represents more than 20% of revenue, expect a haircut. Deals with sub-15% top-customer concentration earn roughly a 0.5x premium. Deals with a single customer at 40%+ are essentially unfinanceable: lenders will not touch that risk profile, and your equity is exposed the moment that customer renegotiates.
Management depth. Search fund operators are buying a business, not a job. If every key relationship, every major decision, and every vendor negotiation runs through the owner, the business is worth less the day the owner leaves. A business with two or three capable managers who can sustain operations without the seller commands a structural premium.
Growth trajectory. A flat business at $2M EBITDA and a growing business at $2M EBITDA are priced differently. Three years of 10%-15% organic revenue growth with consistent margins justifies a top-of-range multiple. A business that peaked four years ago and is defending share is priced accordingly.
The capital stack and what it means for price
A funded search pays for the acquisition with three layers: senior debt (30%-40% of deal value), equity from investors (50%-60%), and seller financing or an earnout (10%-20%). Self-funded searchers using SBA 7(a) loans run an 80% debt / 15% equity structure with 5%-10% seller note.
The seller note matters. When a seller holds paper, meaning accepts deferred payments out of future business cash flow, they stay economically tied to the outcome. Axial data from 100 LOI analyses shows 10%-21% seller note participation is standard across deal sizes, with tech deals averaging 21%. A seller willing to hold paper signals confidence. A seller demanding all cash at close signals something else.
Earnouts: when the price gap is real
Sometimes a seller's asking price and a buyer's supported price are $2M-$3M apart. Neither side is wrong. They are underwriting different futures.
Earnouts bridge that gap by tying a portion of purchase price to post-close performance. Yale School of Management 2025 research found 22% of non-life-sciences deals in 2024 included an earnout structure. That is a meaningful share of transactions.
Earnouts create alignment problems if written poorly. The seller wants to influence decisions that drive earnout metrics. The operator needs to run the business without interference. Every earnout should define specific, objective metrics with no ambiguity about who controls what decisions during the earnout period.
If you cannot write a clean earnout structure that both parties understand in plain language, do not use one.
The most common earnout mistakes: tying payout to EBITDA when the operator controls discretionary spend, setting a multi-year earnout without a clear acceleration clause, and not defining what happens if the business is acquired during the earnout period. Resolve these before you sign. They are far easier to negotiate before close than after.
How buyer type changes the number
A seller with a quality business has options. Understanding the differences affects how a search fund positions its offer.
Private equity firms in the $10M-$50M EBITDA range pay higher multiples because they have access to cheaper debt, established platforms, and a clear path to multiple expansion at exit. They will often beat a search fund on headline price.
Strategic buyers pay for synergies: cost savings, distribution access, product extension. They can justify numbers that appear irrational to a financial buyer.
Search funds compete on something else. A search fund operator is buying a business they will run personally for 5-7 years. They bring operating intensity that a PE portfolio manager cannot match. They are aligned with the business's long-term health in a way that a roll-up platform is not. For sellers who care about what happens to their employees, their customers, and their name on the door, that alignment is worth something.
The pitch is not "we will pay the most." The pitch is "we will run this as well as you did, and better." For more on how search funds approach operations post-close, see our article on the first 100 days after acquisition.
What sellers should know before any conversation
If you are a business owner evaluating whether to sell, valuation starts with your financial statements. Specifically, what a QoE will show. Before you invite buyers into your business, understand what your actual EBITDA is after adjustments. Know your customer concentration numbers. Know which employees leave when you leave.
The seller who knows their business cold gets a better outcome. The seller who gets surprised by a QoE does not.
A search fund buyer will spend 90-120 days in due diligence reconstructing your financial history. That process surfaces every decision you have made about how to run the business. There is no adversarial dynamic. It is the only way a buyer can responsibly underwrite the acquisition. But it rewards transparency.
The sellers who close fastest and at the best terms show up with clean books, a documented management team, and no surprises.
Six questions before you build the model
Before you put a number on a business, answer these:
- What does the QoE show as true EBITDA?
- What percentage of revenue is contracted vs. discretionary?
- What does top-five customer revenue concentration look like?
- Is the management team functional without the owner?
- What is the trailing three-year organic revenue growth rate?
- What capital structure can you support at this price?
If you cannot answer all six, you are not ready to build a valuation model. Build the model after you have the answers, not before.
This discipline matters at every stage of the search. Searchers who skip the foundational questions and jump straight to DCF models or comparable transaction analysis are building precision on top of faulty assumptions. The spreadsheet will tell you whatever you want to hear. The QoE and the management interview will tell you the truth.
Valuation is not negotiation. It is pattern recognition applied to financial data. The deals that fail are the ones where the buyer saw a number they liked and stopped asking hard questions.
The number only means something if the business behind it holds up.
Jonathan Bates is a partner at Patriot Growth Capital and a U.S. Navy EOD officer. Patriot Growth Capital is a veteran-founded private equity firm focused on lower-middle-market acquisitions in the Southeast. Patriot Growth Capital donates 5% of revenue to the veteran community and is affiliated with ATLVets. This article is for informational purposes only and does not constitute investment or financial advice.
