There are three basic approaches that appraisers take to determining the value of a small business interest: (a) cost approach; (b) earnings approach; and (c) market-value approach.  Within each approach, there are multiple methods to arriving at a valuation of a business interest.

The cost approach estimates the value of the business based on the net value of its underlying assets.  Under the cost approach a value is assigned to each tangible and intangible asset owned by the business.  The sum of the liabilities of the business are also determined.  The sum of its assets minus the sum of its liabilities represents the net value of the business under the cost approach.

Under the earnings approach, an appraiser will place a value on the business based on the present value of the future estimated earnings of the company.  An appraiser may look at either a company’s past history of earnings or project future earnings in arriving at a value of the business under the earnings approach.

An appraiser utilizing the market-value approach will determine the value of a company by analyzing the sale price of comparable businesses or the value of publicly-traded stock of companies in the business’ industry.

An objective appraisal will typically be a watershed moment for both buyer and seller in determining the value of a small business interest.  As different valuation methodologies have their advantages and drawbacks, and as each business is unique, an appraiser will often look to multiple valuation methodologies in estimating the value of a business.  While a qualified appraiser best understands the art and science of developing an appraisal, the business owner is the one who most intimately understands the business being appraised.  As a result, it is worth taking the time to carefully review and ask questions when receiving the initial draft appraisal to ensure that the business owner conveys to the appraiser key information about the business that the appraiser may or may not have fully appreciated when developing the initial draft appraisal.  The draft appraisal permits the opportunity for this exchange to occur before the appraisal is finalized.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Call 608-358-9413 to set-up a no-charge initial consultation.]