Business Valuation

The three primary valuation approaches are: (1) Income Approach – values a business based on future earning potential, using discounted cash flow or capitalization of earnings methods; (2) Market Approach – compares the business to similar companies that have sold, using guideline public companies or transaction multiples; and (3) Asset Approach – calculates net asset value by subtracting liabilities from fair market value of assets. Valuators often use multiple methods and reconcile results based on business type, industry, and purpose of valuation.

Professional business valuations range from $5,000-$50,000+ depending on complexity, business size, purpose, and credential level required. Simple valuations for small service businesses may cost $5,000-$15,000. Mid-sized companies with $5-20M revenue typically cost $15,000-$35,000. Complex valuations involving multiple entities, intellectual property, or litigation support can exceed $50,000. Formal reports prepared by CPAs with ABV credentials suitable for IRS gift/estate tax, divorce litigation, or shareholder disputes command higher fees than opinion letters for internal planning purposes.

Common situations requiring business valuation include: divorce (dividing marital interest in a business), estate planning and gift tax compliance, buy-sell agreement triggering events, shareholder disputes and buyouts, merger/acquisition due diligence, SBA loan applications, estate and gift tax returns, litigation (breach of contract, economic damages), employee stock ownership plans (ESOPs), partnership dissolution, and financial reporting for impairment testing. Early-stage companies may need valuations for equity compensation (409A) or investor negotiations.

A minority discount (also called minority interest discount) reduces the value of an ownership stake that lacks control of the business. Minority owners cannot unilaterally make decisions about: hiring/firing management, setting compensation, declaring dividends, selling assets, or taking on debt. Discounts typically range from 15-40% depending on factors like: degree of control minority owners have, voting vs. non-voting shares, dividend history, and marketability. For example, a 25% stake in a $1M business might be worth $187,500 (25% × $1M × 0.75 discount factor) rather than $250,000.

ABV stands for Accredited in Business Valuation, a prestigious credential awarded by the AICPA (American Institute of CPAs) to CPAs who demonstrate expertise in business valuation. Requirements include: being a licensed CPA, completing 75 hours of specialized valuation training, passing a comprehensive exam, demonstrating substantial valuation experience, and maintaining continuing education. ABV credential holders follow strict professional standards (AICPA Statement on Standards for Valuation Services). Courts, IRS, and parties in litigation often prefer valuators with ABV credentials due to their specialized knowledge and ethical requirements.

Service businesses and professional practices with minimal tangible assets are typically valued using the Income Approach, specifically the capitalization of earnings or discounted cash flow method. The valuator calculates normalized earnings (adjusting for owner compensation, discretionary expenses, one-time items), applies industry-appropriate capitalization rates (typically 20-40% for small service businesses), and may add back working capital. Factors considered include: customer concentration, key person dependence, contract stability, recurring revenue percentage, and competitive advantages. Goodwill represents the difference between business value and tangible asset value.

While you can attempt self-valuation, courts generally require an independent expert valuation for divorce proceedings. Self-valuations lack credibility, may be biased, and won’t withstand scrutiny during litigation. Professional valuators provide defensible methodologies, industry benchmarking, appropriate adjustments, and can testify as expert witnesses. DIY approaches risk: understating value (hurting your position if you’re the non-owner spouse), overstating value (hurting your position as the owner), and rejecting by the court. Even if you agree on value with your spouse, having an expert opinion protects both parties from future claims.

Fair Market Value (FMV) is the price at which property would change hands between a hypothetical willing buyer and seller, both being informed and neither under compulsion. It’s an objective standard used for tax, legal, and divorce purposes. Investment Value (or Strategic Value) is value to a specific buyer based on their unique synergies—a competitor might pay more for economies of scale, customer base, or eliminating competition. For divorce or estate tax, use FMV. For negotiating actual sales, understand both FMV and potential investment value to maximize proceeds.

Business valuations should be updated annually for estate planning purposes, when business circumstances materially change, or when needed for specific transactions. Significant events triggering revaluation include: major revenue changes (up or down), new product launches, key customer loss or gain, ownership changes, economic recession, industry disruption, litigation, or regulatory changes. For buy-sell agreements, many experts recommend annual updates or formula-based valuations that auto-adjust. Estate planning valuations should be refreshed every 1-2 years to reflect current FMV for gift tax purposes.

Essential documents include: 3-5 years of financial statements (P&L, balance sheets, cash flow), business and personal tax returns, aged accounts receivable/payable, detailed fixed asset listings, current debt schedules, ownership agreements (operating agreement, shareholder agreements), customer/revenue concentration analysis, employee census and compensation, rent agreements (especially if related-party leases), industry financial data, and current interim financials. For professional practices, include payor mix and fee schedules. Complete documentation enables accurate valuation and reduces time (and cost) for back-and-forth requests.