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.

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.

An uncertain economic climate has persisted since COVID-19 and will continue in 2025. For many small businesses, that means tightening their belts and scrutinizing every dollar spent. One area where many are looking to cut costs is discretionary expenses that, while beneficial, are not immediately critical to daily operations. Third-party independent appraisal work and related consulting services are one area of note. Are small businesses concerned about spending money on external third-party services? Should they view them as being more essential?

Small business owners are continuing to face higher costs and challenging economic times. For those who rely on federal funding or aid, there is even more uncertainty with the current administration’s recent actions. As a result, they are forced to prioritize spending on essentials only, such as payroll, rent, and inventory, while cutting back on marketing, business travel, and professional services, including appraisals.

This strategy will result in immediate cost savings. However, there may be longer-term complications to this approach, especially when valuation and consulting work becomes essential to making sound business decisions. Regardless, many business owners view this type of service as an expense that can be delayed and even eliminated in the short term.

When cash flow is tight, small businesses tend to focus on immediate needs rather than long-term financial planning. Some companies rely on internal estimates, online valuation tools, or informal assessments rather than paying for third-party independent professional appraisals and consulting.d

Despite these cost-cutting measures, valuations remain crucial and obligatory for businesses in certain scenarios, such as bank financing, attracting investors, tax and accounting requirements, estate planning, partnership disputes, divorce, and insurance coverage.

In summary, while economic pressures may push small businesses to cut back on discretionary expenses like appraisals, completely eliminating them can be a risky move. Business owners should carefully weigh short-term savings against potential long-term financial consequences. Strategic spending and engaging with the right consultants who can materially impact the value of your business can help owners navigate these challenging times while maintaining financial clarity.

When was the last time you thought about the value of your small business? If you’re like many owners, the answer might be “not recently” or even “never.” Yet knowing the value of your business isn’t just for when you’re planning to sell. There are many reasons why now is a good time to get your small business appraised.

A small business valuation gives you a clear picture of where your company stands financially. This insight can guide key decisions—whether it’s expanding operations, pursuing financing, or identifying areas for improvement. With a current appraisal in hand, you’re equipped to make more informed and strategic decisions.

From succession planning to preparing for unexpected events, knowing your small business’s value is essential. Life is unpredictable, and having an up-to-date appraisal ensures you’re ready for whatever comes your way, whether it’s an acquisition opportunity or a sudden need to transition ownership.

If you’re exploring partnerships, securing investors, or considering a merger, a current valuation strengthens your negotiating position. It provides a solid, data-backed foundation to discuss terms and ensures you’re not leaving money on the table.

The valuation process often reveals hidden insights about your business, such as areas where profitability can be increased or unnecessary expenses can be reduced. This clarity can help you optimize operations and focus on growth.

Business appraisals are a powerful benchmarking tool. By periodically valuing your company, you can track how it’s growing and evolving, giving you a tangible way to measure success.

In today’s ever-changing markets, being proactive is key to long-term success. A business valuation is more than a number; it’s a roadmap to understanding and enhancing the worth of your enterprise. Whether you’re aiming to scale up or down, sell, or simply safeguard your legacy, there’s no better time than now to get your small business appraised.

Conduct some basic research and find a certified business appraiser who can provide what you’re looking for. Experience, credentials, flexibility, and responsiveness are some of the things to look for in a valuation company that can meet all your needs. Once the process begins, you will find it is much more efficient and effective than you might believe.

There are several components to consider when valuing a small business. The importance of each will vary depending on the business type, industry, and purpose of the appraisal, but the most frequently used are listed below:

Gross Revenue (Sales) and Net Income (Earnings)

These figures represent the heartbeat of the company and will play a significant part in the estimation of value for the company. Income statements will detail all the revenue and expenses of the business. The appraiser will look at both current and historical financial performance to fully analyze revenue and income.

Cash Flow and Debt Levels

Monthly levels of cash flow are crucial for understanding the company's ability to generate liquid cash to cover debts, reinvest, and support ongoing operations. Cash flow and debt level forecasts can also project future financial health.

Assets and Liabilities (The Balance Sheet)

Tangible Assets: Physical assets such as real estate, machinery, equipment, and inventory.

Intangible Assets: These may include intellectual property, trademarks, brand value, and goodwill.

Liabilities: All outstanding debts and financial obligations, including loans, taxes, and accounts payable.

Market and Industry Conditions

The overall economic environment and specific market or industry conditions and trends can influence the small business value. Typically, the better the market, the better the company will perform within it. Specific multiples of revenue and income will be analyzed and used in the overall calculation of value.

Customer Base and Competition

The number and diversity of customers can impact value. A large, diverse customer base reduces risk, while dependence on a few major customers can be risky. Steady clients and a strong brand reputation can add significant value to the business.

The strength and number of competitors in the industry can influence a business's value. A business with a strong competitive advantage (e.g., unique products, intellectual property, or location) is typically valued higher.

Growth Potential

Under the Income Approach to value, appraisers will assess the future growth potential of the business. Stronger growth potential will usually dictate higher value.

Owner Dependence

If a small business is highly dependent on the owner, its value may be lower than that of a more employee-leveraged company. Future buyers may be cautious depending on how long the owner plans to stay on and facilitate a transfer. Businesses that operate independently of the owner often command higher values.

In summary, these are some of the major variables appraisers review and analyze when estimating the value of a small business. Considering all these together provides a well-rounded view of a business's worth and helps determine its fair market value for potential buyers, investors, or during strategic decision-making periods.

Getting your small business valued is essential, especially if you want to make informed financial and strategic decisions. Here are some key reasons why a business valuation is crucial:

1. Understanding the True Value of Your Business/Internal Planning

   An appraisal helps you understand what your business is actually worth. Many owners have a general idea, but a formal valuation gives you a clear, objective figure based on market trends, financials, and future potential.

   A valuation can also be a benchmark for tracking your business's financial health and growth over time. It can highlight areas that need improvement and allow you to set measurable goals.

2. Selling or Merging a Business

   Knowing your business's value is essential to negotiating a fair deal if you're planning to sell or merge it. It also ensures you're not underselling or overestimating your company when approaching potential buyers or partners.

3. Attracting Investors or Raising Capital

   Investors will want to know your business's current value before committing funds. A certified appraisal helps attract investors and secure better terms in funding rounds or when applying for loans.

4. Exit or Succession Planning/Tax & Estate Issues

   If you plan to retire or want to determine a sound exit strategy, a business valuation helps in planning for the transition. It also assists in setting fair expectations for all parties involved.

   Independent objective appraisals are necessary for estate planning, especially when passing on your business to family members. They ensure compliance with tax laws and help minimize tax liability during inheritance or ownership transfers.

5. Litigation and Legal Matters

   In cases of divorce, shareholder disputes, or business litigation, a formal valuation is often required to resolve the financial aspects. It provides a clear figure for settlements, buyouts, or compensation.

For these reasons and others, it makes good business sense to have your company appraised by an independent valuation professional to ensure you have a true and objective picture of its value in order to make fully informed choices.

We speak with small business owners daily about their interest in obtaining a valuation, usually for a specific and immediate purpose. The reasons typically involve any of the following:

• The owner is going through a divorce
• A partner wants to buy out their shares, or a new investor wants to buy in
• Refinancing or SBA Loan requirements to obtain working capital
• A potential sale or acquisition of a small business
• Estate Settlement/Transfer or Gift Tax
• Setting up a Trust
• Litigation Support
• Internal Business Planning

The last one listed here is the most interesting because it tells me that a business owner is likely thinking proactively to better prepare themselves for future development plans, ideally in the company's longer-term growth planning stage.

Rather than waiting for something to happen that triggers a more urgent need for an updated small business valuation, it might make sense for owners to have professional appraisers conduct annual valuations of their business so that whatever happens down the road, they will be better prepared to face the challenge.

We often witness an owner's hesitation to move forward with an appraisal once we provide a scope of work summary and fee quote. This may be a matter of cost or unwillingness to commit to the work effort involved. Whatever the reason, it's important to think about the decision not only in terms of the immediate need but also with an eye on the additional benefits an appraisal can provide as you continue to be a successful small business owner.

Partnering with a third-party consultant such as a certified appraiser, tax planner or investment advisor, can give you additional perspective from an "outside-in" view that can help you along the way as the company continues to evolve. I think you'll find that the additional time and investment involved with this type of engagement will be minimal in comparison to the overall benefits of fully understanding the worth and potential of your small business.

Let us know if you would like to discuss these topics further by reaching out to us through our website. We would be happy to speak with you personally.

There is a misconception in the valuation industry, which some of our clients express their concern over, that their appraiser needs to be located in close proximity to where their company is situated. It is understandable that a small business owner, who themselves may have several local relationships with their own clientele, would raise this issue; however, the fact is that experienced, certified professional appraisers can effectively value any company, regardless of where it is located, and what local markets it may be operating in.

During the valuation process, a qualified appraiser will work with their clients in a “hands-on” fashion to gather all the specific company information needed to complete an accurate and supportable analysis, and ultimately deliver a full narrative report. Each client has the opportunity to discuss the details of their company that go beyond the black-and-white picture created by their tax returns, income statements, and balance sheets, allowing for reasonable adjustments to be made that paint a more colorful, complete, and truer picture of their business.

The appraiser has access to market and industry data across every region in the country and will take into account the nuances of how the company works within these areas, in relation to their competitors and client base. They will look to understand the specific strengths and weaknesses the business has, as well as their ability to leverage the former and improve on the latter. Future growth plans will be considered regardless of whether they are aggressive, modest, or even negative.

Based on the sum total of the data provided, an educated, trained, professional appraiser considers the same set of consistent approaches and methodologies for every valuation and determines how best to apply and weigh each one specifically to the business. The underlying assets of the company will be taken into account, as well as the specific purpose and effective date of the appraisal.

As you can see, the appraisal process is a collaborative effort that relies upon both the independent valuation professional and the business owner/representative to work together and develop a complete snapshot of the company. By the time the project is over and the report is delivered, it will become clear how well the appraiser understands the business, even though they weren’t local to the area.

With 2024 in mind, many of us vow to change a habit or two and get a fresh start on improving our way of life with the proverbial New Year's Resolution. This change in mindset can often be fleeting when the thought process does not materialize into instant benefits after minimal dedicated work effort. The brain can quickly adjust back to telling you that everything is fine, and you feel pretty good about yourself.

The same can be said for your business where it is much simpler to continue with the old way of doing things, especially when the year-to-year results are solid, and you and your staff seem content with current operations. There might not be any reason to overhaul your business model, however, you can always be more proactive in looking ahead and tweaking a couple of things based on recent experiences and increased knowledge.

One of these adjustments should involve not waiting for a reason to take a concrete look at your company and establish a baseline value, so you can better measure the real worth of all the effort you’ve put behind it over these past years and create a tool that can monitor progress in the future. Obtaining an independent, professional appraisal of your business is always a good idea, regardless of what might otherwise force the need to complete one as part of a pending transaction.

Most business owners wait until they absolutely need to have a valuation done, in complement to such things as bringing in or buying out a partner, a personal divorce, or refinancing debt to obtain working capital. As a result, there is a sudden rush to get it completed, and the added pressure of working through the process can further stress an already time-consuming and tedious situation.

If you have already recently completed a valuation, while using an experienced, accredited appraiser, it is simply a matter of sharing this report with the appropriate parties and immediately checking the box for this requirement. Advising your valuation expert that the purpose is for “internal business planning” will allow you to utilize the report for most of these future developments. Getting into the habit of updating the business valuation annually will make it more certain that the results are current and will be sufficient for any third party to review and consider as part of the larger transaction.

Being proactive is generally considered a benefit in your day-to-day life. Having a similar game plan when it comes to your business is just as important, if not more critical when it comes to continued success.

When there’s a need to settle someone’s estate, there are a lot of things to consider, and given the emotional component of this difficult and hectic time, it can become overwhelming. If the individual wholly owned or was a partner in a business, you will need to consider placing a value on these estate assets, to properly and fairly include them in the settlement. It’s important to work with an experienced independent appraiser who understands the best methodologies to consider and has no “skin in the game” that might create a biased opinion.

When reviewing the ongoing businesses under the estate, it is also a good idea to look ahead at how you believe the future of the company may be affected by the prior owner or partner no longer being involved. Is there an opportunity to sell the company before the effects of their absence take effect? Are there factors to consider in taking the company forward under new direction or management?

While you’re taking care of the short-term demands involved in settling the estate, discuss these more proactive topics with an appraisal professional who can provide options where the valuation might consider these additional perspectives. It’s often feasible for an appraisal consultant to assist not only with valuing the business as of the effective date under the estate settlement but also look ahead at a more current date for the purposes of a future sale or change in the structure of the company.

Before you decide which consultants to engage with during this trying time, inquire as to their ability to work with you on multiple fronts so you can accomplish more than the immediate objective and determine if they can assist with all or most of the concerns you may be thinking about today.

It’s difficult enough to handle all the tasks involved with settling an estate, especially if the individual owns a large number of assets. The more support you have to accomplish all these, the better your ability to manage everything in a timely and effective fashion.

If you are in the middle of an estate settlement, consider reaching out to professional consultants such as certified and accredited appraisers, who will be there the moment you need the assistance.