A business valuation is done for several reasons, including preparation for a sale or when passing ownership to the next generation. The latter is especially relevant now as the Unified Tax Credit, which defines the combined tax-free exclusion of gifts made during a person’s lifetime and the value of their estate before 40 percent estate taxes apply, is scheduled to be reduced. On Jan. 1, 2026, the exclusion, currently approximately $13.6 million, is scheduled to be reduced to approximately $7.2 million. The limits for married couples are double the single amount. It’s a lot of value, but for some with successful businesses and/or significant personal assets, the reduction will make a difference.
Just as important, a smart business can use the information in the valuation report to make improvements that can make itself more profitable and valuable.
Smart Business spoke with Brady Ware Senior Manager Robert W. Evans about business valuations — how they’re calculated, and how they’re used.
How is a business valued?
In business valuations, fair market value is the price that a business would fetch from a hypothetical buyer in an arm’s length transaction, even though that number could be different than what a company sells for. Some businesses sell for more because a particular buyer sees a strategic value in the business. Others sell for less.
There are three primary approaches to value a business. The income approach calculates value based on a company’s adjusted historical net cash flow. It starts with EBITDA, makes fair market value adjustments for related party expenses such as owner’s compensation and related party rent, removes non-recurring income and expense and deducts capital expenditures. Personal expenses on the company’s books are also added back. The adjusted net cash flow is then discounted by a percentage that includes consideration of the company’s unique risk profile to arrive at a value.
The market approach relies in part on subscription services that report by industry the multiples for sales of similar private companies. For larger companies, public company data can be used alongside or instead of the subscription services.
The asset approach adjusts the book value of the assets and liabilities of a company to fair market value. Appraisals are sometimes needed to make the adjustments. The asset value typically produces the lowest value because there is no goodwill; however, companies with little or no profits and asset-heavy companies may find that the asset approach gives the highest value.
After a preliminary value is determined, discounts are applied to address issues such as a lack of marketability — no privately held business can be sold as fast as publicly traded stock — and the lack of control. The discounts are important because they reduce the company’s value and permit more assets to fit into the Unified Credit.
What’s the difference between a valuation and an appraisal?
With an appraisal, the value is determined by the fair market value of the assets, less liabilities. But a valuation of a business includes the earning capacity of the conglomeration of its assets, customers, products, employees, etc., which can be worth more than the net value of the assets. That extra value is called goodwill.
A business valuation is an extensive report that can be 100 or more pages, including a narrative covering a description of the company, the market that it operates in, the economic conditions at the time of the valuation and more. A calculation of value uses the same numerical analysis, but the report is much shorter — just a few pages — and it’s less expensive.
How can business owners leverage a valuation to increase company value?
Some savvy business owners are getting a valuation or calculation of value a few years before listing their business for sale, then use that information to improve profitability and make the business more valuable when they sell it. Many reports also contain valuable benchmarking data showing the competition’s financial ratios and expense structure, information not freely and publicly available.
Too often, when business owners get a valuation, they stick it in the drawer and never look at it again. But if they study it, there are things that they can learn to make their business better and more valuable.
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