Business Valuation Blog | Understanding Buying / Selling a Company

Jane and John each own their own small accounting practice and are each getting ready to retire.

They have equivalent staff costs, rent, and other overhead. Further, they each generate approximately $250,000 in annual owner earnings, and have done so consistently for many years. However, the similarities stop here.

Jane has three long-tenured employees with significant responsibilities. John has five interns and makes all the big decisions himself.

Jane has a steady book of recurring annual clients. John focuses on walk-in clients and has relatively high turnover.

Jane’s landlord is willing to sign a new extended lease with a new business owner after typical due diligence. John’s landlord will agree to assign his existing lease until end of term, but will not discuss renewal until later.

Two businesses with identical financial performances – but very different values.

Business Buyers Are Purchasing the Future

In many ways, buying a business is no different from buying a car. Two cars may be identical and both run perfectly. Yet the car with higher mileage is going to be worth less because the risk of unforeseen maintenance and repairs increases along with mileage.

The past performance of the car is an important indicator of its future performance, but not a guarantee. The car with the better chance of continuing its past performance – the car with the lower purchase risk – is the car which sells for more.

The same principles apply to business purchases.

In the opening example, Jane and John’s historical performance is identical. Each owner has generated the same amount of owner earnings consistently. However, their chances of continued performance are very different!

Jane has:

• More experienced employees.
• More recurring revenue.
• Safer tenancy arrangement.

Because of these risk-mitigating factors, Jane’s past earnings of $250,000 per year seem likely to continue for the next owner.

• Heavy reliance on himself.
• Non-recurring customers.
• Uncertain future tenancy.

The next owner would be essentially gambling that they could navigate each of these situations successfully in order to continue John’s past earnings.

Business buyers are not interested in what Jane and John have achieved in the past. They are buying the ability and probability of achieving the same results in the future.

Despite their identical past financial performance, the risk of continuing performance is very different for Jane and John! Jane's business is more likely to continue performing at its current level; therefore it is worth more than John's.

What Makes a Business More Risky?

Every business owner holds a unique package of advantages and risks. However, most professional business valuations consider similar broad factors which may affect the future performance of a company.

Some common examples include:

• Customer concentration: is your performance heavily dependent on a small number of individual relationships?
• Owner reliance: could the business operate successfully without the current owner’s daily involvement?
• Employee retention: will key managers and skilled practitioners remain with the business post-acquisition?
• Declining or competitive markets: are your margins getting squeezed due to economic or industry trends?
• Earnings consistency: is recent performance the norm, or has the business benefited from unusually favorable conditions which may not continue?
• Overdue expenses: will the new owner be saddled by deferred maintenance, equipment replacement, building repairs, or obsolete software?
• Skeletons in the closet: are there any pending litigation or regulatory issues for which a new owner may be responsible?

A business valuator will consider the entire picture of risks and advantages when developing a business valuation. Business buyers may not use the same methodological approach as a business valuator, but they instinctively consider many of these same factors and will adjust their purchase offers accordingly.

Risk Does Not Mean Something Is Wrong

Every business investment carries some level of risk. The opportunity to earn a financial return exists because there is a chance that the investment will not perform as expected. In general, investments with lower risk offer lower returns, while higher-risk investments must offer the possibility of greater returns to attract buyers.

For example, U.S. Treasury securities are considered among the safest available investments. The risk of losing money is relatively low, but so is the potential return.

Commercial real estate generally carries greater risk because future returns depend on occupancy, maintenance costs, financing, and local market conditions. Investors accept those uncertainties because they expect higher returns.

By comparison, small privately held businesses are generally considered to be among the highest-risk income-producing asset classes.

Regardless of the industry, every business depends on customers, employees, competition, economic conditions, and countless other factors that cannot be fully controlled. Even well-managed businesses with long operating histories face uncertainty about future performance.

But these risks are balanced by the opportunity for exceptional returns. A successful small business may produce financial returns far exceeding those available from safer investments. Many businesses can be started with relatively little capital investment. Many of today's largest companies began in the founder’s basement or garage.

Therefore, business owners should not expect to eliminate every risk. Risk is an unavoidable part of owning and operating a business. Instead, owners should focus on identifying unnecessary risks, reducing them where practical, and demonstrating to prospective buyers why the business is well positioned to succeed despite the uncertainties inherent in ownership.

Understanding Risk Helps Owners Make Better Decisions

Reducing risk does not guarantee a higher business value, but reducing unnecessary uncertainty generally makes a business more attractive to potential buyers.

Business owners often focus solely on current revenue and profitability, which are certainly important drivers of value. Owners who take the extra steps to mitigate performance risk will strengthen their company's marketability and increase business value potential.

A professional business valuation considers both financial performance and the risks associated with future earnings. Understanding how those factors work together can help owners make more informed decisions when planning for a sale or transition of any type.

Business owners and advisors tend to assume that higher revenue equals higher business value. It’s natural to believe that more customers, more employees, and more activity should create a more valuable business.

While growth can increase value, revenue alone does not necessarily translate into higher valuation conclusions. Buyers are usually less interested in how much a business earned last year than whether those earnings are likely to continue for the next owner.

An independent business valuation looks beyond top-line growth and considers earnings quality, future expectations, and the risks that affect enterprise value.

Growth Is Only Valuable If It Produces Returns

Growth solves some problems and creates others. More employees, more inventory, and more locations may increase revenue, but they also require additional investment and coordination.

A business generating $5 million of stable and efficient revenue may ultimately be more valuable than a similar business generating $8 million of volatile revenue with more complex operating demands.

Beyond margins, two businesses with identical revenue may have very different risk profiles based on customer concentration and lead generation channels. Typical concerns of business buyers and valuators may include:

• Is revenue concentrated among a small number of customers?

• Are there recurring or long-term contracts?

• Is lead generation tied to the owner or other key employees?

Diversified and stable revenue will typically support stronger valuation conclusions than revenue that is concentrated and unpredictable.

For example, consider two businesses each producing $10 million of annual revenue. The first generates revenue from hundreds of recurring customers with no individual customer exceeding 5% of sales. The second relies on three customers representing 80% of revenue. While total sales may be similar, buyers may perceive materially different levels of risk and reach very different conclusions regarding value.

Growth Can Increase Operational Risk

Business growth often creates operational complexity. As businesses expand beyond the owner and a small core team, quality control, communication, and management oversight become increasingly important.

Processes that worked well for a small organization may require additional systems, structure, and management as the business grows.

Additional concerns associated with growth may include employee turnover, human resources complexity, increased facility requirements, and reduced direct connection with customers.

Unless these and other growing pains are managed intentionally, increased complexity may reduce business value relative to revenue.

Growth Often Requires Additional Investment

Beyond operational complexity, revenue growth does not always create immediate business value because growth frequently consumes capital.

New employees require recruiting and training. Expanding facilities require additional occupancy costs. Growing inventory levels tie up working capital. New equipment and technology may require substantial investment before additional earnings are realized.

From a valuation perspective, higher earnings are not automatically better if they require disproportionate investment to maintain.

A business that produces stable cash flow with modest capital requirements may support stronger valuation conclusions than a faster-growing business requiring continual reinvestment.

Growth Does Not Always Improve Transferability

Business value may also be influenced by whether performance is likely to transfer to a future owner.

Growth that depends heavily on the current owner’s relationships, reputation, or direct involvement may not increase value to the same extent as growth supported by systems and broader management responsibility.

In some cases, even an owner who is not involved in day-to-day operations may still influence revenue through reputation and industry relationships. Buyers must consider how customers may respond when that individual is no longer affiliated with the business.

Businesses supported by documented processes, diversified customer relationships, management depth, and repeatable lead generation are often easier for buyers to underwrite and may support stronger valuation conclusions.

Not All Revenue Is Viewed Equally

From a buyer’s perspective, not all revenue feels the same. The source, quality, and predictability of revenue will affect perceived business value.

Recurring service contracts, diversified customer relationships, and repeat purchasing behavior may be viewed differently than one-time project work or highly cyclical demand.

Similarly, growth driven by temporary market conditions may not carry the same weight as growth supported by durable competitive advantages or demonstrated customer retention.

A business experiencing moderate but predictable growth may ultimately support stronger valuation conclusions than a business experiencing rapid but inconsistent expansion.

Buyers Purchase Future Performance

Business valuations are ultimately forward-looking. Buyers do not want to pay for past results; they want to acquire future performance.

Buyers are likely to evaluate operational sustainability, management depth, employee retention, projected cash flows, capital investment requirements, and the ability of earnings to continue after ownership transition.

Businesses supported by documented processes, broader management responsibility, and customer relationships that extend beyond the owner may reduce transition risk and support stronger valuation conclusions.

Historical growth remains important, but expectations regarding future performance carry significant weight in a business valuation.

Business Valuation Creates Context

A business valuation is not a one-size-fits-all score.

An independent business valuation can help owners identify which parts of their business are creating value and which parts are creating risk.

Understanding business value before a transaction, ownership transfer, or succession event may support better long-term decisions.

Business owners can use valuation results to identify risk factors within their business and improve the quality and sustainability of future growth.

One of the most exciting and daunting experiences for a business owner is when they begin to consider selling their company. After years of hard work, the day arrives when they believe the best option is to cash out and move on to the next chapter.

An essential step in the process is obtaining an independent valuation to better understand the business's market value, including its underlying tangible assets and goodwill. The appraiser selected should be certified by NACVA, ASA, or another nationally recognized association. Make sure to discuss their credentials before moving forward.

If there are significant amounts of equipment and the buildings and land are owned, also engage with accredited appraisers who specialize in those areas while completing the full company valuation. These tangible values will then be transferred to the business appraisal as part of the overall review and analysis.

Taking time to go over financial documents with the appraiser is critical so they understand the adjustments to non-recurring and discretionary expenses that should be made. This will factor into the company's profitability. Two of the variables in the analysis will be gross revenue and adjusted net income (EBITDA), along with the potential for future growth, which can be determined through a reasonable forecast of revenue over the next 3-5 years.

It is usually expected of the owner to retain on-hand cash and receivables from finished projects and to settle liabilities, including outstanding debt. Hopefully, the net outcome for this is positive, so they can walk away with additional cash to supplement the overall sale price.

Buyers understand they will need to develop their own sources of cash flow, whether through their own capital, new loans, or investor equity.

Selling a business requires patience and effective communication to provide all necessary supporting documentation to appraisers and potential purchasers; therefore, one option is to engage a business broker familiar with the industry and the markets in which the company operates, who can assist with the overall process. In the end, it is important to feel confident with all the terms of the deal while carefully reviewing the documentation involved.

Sellers should consider hiring a business attorney to ensure all bases are covered and that legal issues are fair. Closing the sale should be one of the most satisfying events in a business owner’s career, so it is important to work through the process with the best support team available.

As a small business owner, it is important to stay current on the value of your business. Having an independent professional appraisal completed annually is the best way to handle this. Here is a brief summary of the process that will take place:

Business valuation is a specialized field that offers accreditation through recognized organizations. Look to engage a certified appraiser with sufficient experience to ensure an unbiased and thorough assessment. Two of the better-known associations are the American Society of Appraisers (ASA) and the National Association of Certified Valuators and Analysts (NACVA).

Once you describe your business and current situation to the appraiser, they will quote a scope-of-work fee and, if accepted, follow up with a formal engagement agreement.

It is important that you have accurate financial records available for the appraiser and that the most recent statements have been prepared. If they are lacking, have your accountant review and update your records.

The appraiser will consider and rely upon different approaches to determine a business's worth:

• Income Approach: Examines the business's earning potential and cash flow. If your company is continually meeting goals and growth expectations, this methodology will be important to measure.
• Market Approach: Compares the business to similar ones recently sold and factors in gross revenue and net income. Specific market multiples will also play a part in developing value.
• Asset-Based Approach: Focuses on the company's net assets minus liabilities. This approach may apply to companies with large capital equipment and real estate investments.

The choice of methods will depend on several factors, including the industry and the company's current operational state.

The appraiser will communicate with the business owner, gather financial data, and provide a questionnaire covering the company's history and structure. Ensure you provide full disclosure regarding revenue trends and profitability, how the market and industry affect your operations, whether there are ownership (buy/sell) agreements in place, and what discretionary adjustments should be made to the income statement and balance sheet.

In summary, providing clear, well-supported documentation to the appraiser will result in the most accurate and credible outcome. Once you have a formal, current appraisal report in hand, you are prepared for ongoing or anticipated events in your small business where value plays a role in the transaction.

When professional appraisers value businesses and tangible assets, they are educated to consider and rely on a consistent set of methodologies, regardless of the industry or type of asset being appraised. These approaches are critical to understanding how accredited appraisers become independent experts in the field of valuation. Without this set of guidelines, the industry would become a Wild West of unregulated methods, with no unbiased governance.

That said, there are several different variables within each market and industry that will influence the valuation of the subject property being appraised. The overall scope of work and available data will also dictate which methodologies will ultimately be relied on.

In business valuation, for example, multiples and risk premiums relied upon under the market and income approaches will vary depending on the specific company and industry involved.

With machinery, the available market data for new and used equipment will dictate how much weight can be placed on the cost and sales comparison approaches. The useful life and effective age of a particular asset will also affect its value.

These distinct variables will affect the conclusion of value; however, the appraiser needs to remain consistent with the universally accepted approaches they are taught to consider and rely on.

It’s perfectly acceptable to exclude certain approaches if the data is not there to support them or the situation doesn’t call for them. For example, the income approach is rarely used when appraising machinery and equipment; however, it is one of the more common methods when valuing small businesses. This is due in part to the difficulty of tying revenue and expenses directly to a business's underlying tangible assets.

The definition of value being applied will also factor into the determination of the appropriate approach. Fair Market Value-Installed is a concept distinct from Orderly or Forced Liquidation and may determine which methodology is more reliable or supportable.

In summary, every valuation will have its own distinct components that influence its direction; however, the appraiser must use the same consistent set of approaches and methodologies for every project they take on.

As accredited appraisers, we are frequently asked how experienced we are in a particular industry when potential new clients inquire about our expertise. Most appraisers are considered “generalists” and cannot afford to focus a significant amount of time on any one industry if they want to maintain steady revenue and grow their business. There are numerous industries in which companies operate, and it is important for appraisers to apply their skills within all of them to create a diverse valuation practice.

Appraisers go where the opportunities take them, regardless of the industry in which their clients operate. If a valuation expert has been working professionally for a long time, they have likely completed a certain number of appraisals in many different industries, which increases the odds they have experience in the ones they are being asked about.

It’s important for clients to understand the distinction between industry and valuation expertise. They are two very different service provider segments that will intersect at times, but will demand professionals focus their expertise on one or the other. As an appraiser, it is not difficult to become generally well-versed in the industries in which they work when conducting appraisals. Combining the market research developed for each project with direct client communications enables them to understand what they need from an industry perspective to complete an effective valuation.

The standards and methodologies learned and employed by certified and accredited appraisers apply to every industry they work in. All the educational time and effort, as well as the application of these accepted approaches, are consistent for any company being valued. The more experience a valuation expert has, the more it will reinforce the understanding that employing these methods will provide greater support and credibility to their analysis and reporting process.

It is important to understand the nuances of the industry in which you are valuing. There are databases and market sources that provide this kind of information at the appraiser's disposal, if they know where to look. This data will influence the valuation conclusions and is typically based on a considerable number of comparable companies within the same industry.

Regardless of an appraiser's level of experience in any industry, they can provide a credible, supportable valuation of your business if they hold the proper credentials that make them experts in the appraisal industry.

If you have a partner who is looking to leave or is considering bringing in another investor into your small business, you will want to negotiate a fair buyout or buy-in with those involved to avoid a dispute. As certified appraisers, we see many instances in which the process has dragged on for months with no agreement, due in large part to the fact that the parties on each side of the transaction cannot reasonably agree on price.

There’s a lot at stake when valuing ownership shares amid the exit or new entry of investors, and it is common for different perspectives on value to become a sticking point. Before you enter into your first serious conversation about value, you should engage with a professional appraiser who can provide an independent, unbiased opinion of the value of the company as well as the percentage ownership share involved. They will work closely with you to gather the data needed to understand and analyze your business's financial details, while researching the specific industry and market in which you operate. You will have an ongoing open line of communication with the valuation expert to highlight any nuances and adjustments that need to be considered with your business while providing further insight that isn’t readily apparent from the income statements and balance sheets.

One of the frequent areas of dispute in these negotiations is whether to apply discounts to minority ownership interests and, if so, the level of those discounts. This approach may be appropriate if the ownership is considered non-controlling, which typically involves a share of less than 50%. These discounts reflect the lack of control a shareholder would have over the company's operational decision-making, as well as a reduced ability to sell their shares in the market to a third party due to the non-controlling interest.

It will be important to discuss all these topics during the appraisal analysis with your valuation professional, so everyone is on the same page regarding the underlying factors that will affect the value of your company and its associated shares.

To avoid wasting time in the negotiating process and reduce the chances of a serious dispute or even a legal battle, advise the parties involved that you will be engaging with a certified appraiser to conduct an independent valuation of the business and the percentage shares involved with the buy-in or buyout. Once the report is delivered, you can share the results and begin settlement discussions from a non-contentious point, greatly increasing the odds of an amicable transaction.

Remember to do this early in the process to firmly establish the ground rules and maintain a level of control over the process. As a business owner, the end result will impact you more than anyone else involved.

Business owners should be cost-conscious with many of their annual expenses; however, there are certain areas where price and convenience should not be the defining factors. When you want to best understand the value of your business, the only path you should consider is the old school standard. Premium quality and service mean better results you can depend on.

The cheap and easy route might save you money in the short term; however, it can come back to haunt you later. Quality can be measured in several ways, so determine what is most important to you when it comes to working with your valuation service provider before deciding on whom to engage with.

In today’s AI-driven world, it might seem fast and simple to just use an online tool to plug in a few numbers that spit out a value. But these gimmicks are unreliable, informal, and unsupportable.

Think about the following things when considering appraising your company:

Customer Service from Start to Finish

Who is communicating with you most effectively and consistently when you are inquiring about purchasing the product or service? Are they making you feel like the most important client from day one, even before you commit to collaborating with them? Do they follow through with that same level of communication and delivery after you have contracted with them? If the cheaper price leads to poor customer service and late deliveries, you have made the wrong choice.

Reliability of the Product or Service

Are you receiving the best, most dependable product that you expected and are required to have to satisfy your business’s transactional needs? What are the costs to your business if you receive inferior service? Might you suffer a hit to your own company’s reputation or end up on the losing end of a business dispute due to inferior quality?

Your Own Time and Effort Costs Money

Will engaging with the cheaper vendor be more time-consuming for you or your employees? Does the less expensive provider have enough experience and professionalism to save you time and effort? These types of qualities are critical to the process, and without them, you will end up with an inferior product that costs you too much time, which translates to lost revenue.

In summary, consider all the benefits that go along with choosing quality over cost. Don’t find out the hard way that the cheaper alternatives are not all they are cracked up to be.

When valuing small businesses, the appraiser must first understand the circumstances for which the report is being prepared. Unlike machinery and equipment appraisals, where the definition of value is the key variable driving the conclusion, business appraisals will lean more on the purpose and scope of work to determine the best way forward.

For example, if the reason is for an outright sale of the company, the appraiser will need to exclude cash, receivables, and liabilities from the balance sheet since the seller will take these current assets and obligations with them as part of the closing transaction.

If the purpose is a minority share buy-out or buy-in, the business appraiser will need to consider and apply lack-of-control and marketability discounts to the percentage shares being purchased or sold. These discounts will factor heavily into the share value unless the owner or potential buyer has a 50% or greater interest in the company.

Another example is in a divorce scenario, where the company being valued is part of a contested or negotiated asset division. There may be factors pertaining to the ongoing litigation or settlement that will need to be considered before finalizing the value.

How the appraiser calculates and weights the different approaches is also a driving factor that plays into methodology. A business can be valued in different ways, using a discounted cash flow and/or multiples of gross revenue, EBITDA, net income, and discretionary earnings. How these differing conclusions are ultimately weighed will influence the overall estimate of value.

There is always a degree of subjectivity in the ultimate reasoning behind any appraisal. Opinions will differ depending on the data relied upon, the methodologies used, and the appraiser's experience. They need to make sound, common-sense decisions based on supportable data to reach conclusions about value.

As a professional appraiser, all of these critical factors must be carefully considered throughout the valuation process. If you are an accredited valuation professional, always strive to fully understand the big-picture perspective of the underlying transaction your work product will apply to. The purpose and scope of work are important components of developing your appraisal framework. The more you know about your role within the confines of the larger deal, the better your decision-making will be.

As Artificial Intelligence (AI) advances, the impact on numerous industries is becoming more apparent, creating a shift from the heavy reliance on human expertise to automated technology models. The business valuation industry is no exception. Certified appraisers, long trusted for their judgment, experience, and nuanced analysis, are beginning to face competition from AI-powered tools that can process vast amounts of financial and market data in seconds.

Valuing a business in the traditional sense requires several hours of review and analysis with financial statements, comparing industry benchmarks, and applying subjective judgment to factors like risk, growth potential, and market conditions. AI systems can now automate much of this work by leveraging machine learning models trained on thousands of past valuations. These tools can generate highly consistent, data-driven estimates at a fraction of the time and cost.

One of the biggest advantages AI brings is scalability. What once required a team of appraisers can now be handled almost instantly by software, making business valuations more accessible to small business owners who can’t afford professional services. AI also reduces potential human bias, applying standardized methodologies across all cases rather than relying on individual interpretation.

This shift does not mean human expertise will no longer be needed. It should adapt and evolve, especially with more complex cases involving unique assets, legal disputes, and intangible factors. Human insight will always play a role in independent appraisal work; however, for routine valuations, especially in lending, mergers, and financial reporting, AI models may become the norm.

It will become even more important for valuation companies to explain that the importance of working with experienced independent appraisers is more dependable and supportable than relying heavily on AI models. Regardless, the continued advancement and integration of AI in business valuation will result in an undeniable shift. Certified appraisers are no longer the sole gatekeepers of valuation. They may instead need to become more relevant as reviewers, interpreters, and advisors, working alongside AI rather than competing with it. Eventually, those who adapt to this new reality will thrive, while those who do not may find their role increasingly diminished.