Capitalisation of Earnings: how the multiple actually gets chosen

The three steps inside the method

Cap of Earnings has three steps, and the work in each one is very different:

1. Normalise the earnings. Reported EBITDA usually isn't the number a buyer will pay a multiple of. It needs adjustment for items that wouldn't recur under new ownership.
2. Find the published multiple range for comparable transactions in the same industry and EBITDA size band [1].
3. Position the business inside that range using a risk-adjusted assessment of operational factors.

Most owner attention goes to step 2 (the multiple). Most of the actual movement happens in steps 1 and 3.

Step 1 — Normalising the earnings

A buyer doesn't want to pay a multiple of EBITDA that included things they're not going to inherit. Common normalisation adjustments include:

• Above-market owner compensation (or below-market, where the owner under-pays themselves)
• Personal expenses run through the business — vehicles, travel, family on payroll
• Related-party rent above or below market
• One-off legal, restructuring or insurance costs
• Discontinued product lines, divisions or contracts
• Non-recurring revenue (one-off projects in a recurring-revenue business)

The buyer's Quality of Earnings process exists specifically to test these adjustments. Sellers who have a clean, documented, defensible normalised EBITDA going into the process don't need to negotiate this on the back foot.

Step 2 — Finding the published multiple range

The multiple isn't your opinion or the buyer's opinion. It's what comparable businesses in the same industry and size band have actually transacted at. The IBBA Market Pulse Report [1] and the Pepperdine Private Capital Markets Survey [2] are the two most-cited public sources for the lower-middle market.

The crucial point: each industry shows a range, not a point. A single industry in the $1M–$5M EBITDA band typically shows a spread of 3.0× to 6.0× across actual completed transactions. That spread isn't noise. It's the market pricing operational quality.

Step 3 — Positioning inside the range (where the real movement happens)

This is the step most owners underestimate. Two businesses with identical EBITDA in the same industry can — and routinely do — transact at meaningfully different multiples. The factors that determine where inside the range a specific business sits are consistent across advisor practice [2]:

• Owner dependence — does the business run through one person?
• Customer concentration — what % of revenue sits with the top 1, 5, 10 customers?
• Recurring vs. project revenue mix — how predictable is next year's number?
• Quality of financial reporting — accrual accounts, monthly close, defensible KPIs
• Depth of the management layer — who runs the business if the founder is on holiday?
• Process documentation — is the operation written down, or is it in someone's head?

A business strong on all six anchors at the top of its industry range. A business weak on all six anchors at the bottom — or doesn't transact at all.

Where XLev's work shows up

We don't change the published industry multiple. The market sets that. We change where inside the range a specific business credibly sits, by reducing the six operational risk factors a buyer uses to argue for the bottom of the range. The arithmetic of the method doesn't change; the inputs to the risk assessment do.

See also How businesses actually get valued for the wider context of where Cap of Earnings sits alongside DCF and the Asset method, and From 3× to 5×: what buyers actually pay for for the operational moves that move position inside the range.