Not tax or legal advice. This article is general information based on my own experience selling a business. Every business and deal is different. Talk with your own CPA, attorney and financial advisor before acting on anything here.
The short answer
"What is my business worth?" is really two questions. What would the IRS, a court or a lender accept? And what would a buyer actually pay? A formal valuation (a written appraisal by a credentialed appraiser) answers the first. A valuation range answers the second. You need a formal valuation when someone outside the deal has to rely on the number, such as for gifts of shares, trusts, estates, ESOPs, partner buyouts, divorces and many lender-financed purchases. For deciding whether and when to sell, a range is usually the right place to start.
Formal valuation: built to stand up to scrutiny
A formal valuation is done by a credentialed business appraiser following professional standards, and it produces a detailed written report. For tax and ESOP purposes it measures fair market value: the price a hypothetical willing buyer and willing seller would agree on, both reasonably informed and neither forced to act. That can include discounts for minority or hard-to-sell shares. Divorces, partner disputes and buy-sell agreements sometimes use a different standard or a formula set by state law or the agreement. A formal valuation takes weeks and often costs thousands of dollars.
You typically need one when:
You gift shares to family or move them into a trust. (An appraisal that meets IRS disclosure rules is the usual way to support the value on a gift tax return.)
You're settling an estate.
You have, or are setting up, an employee stock ownership plan (ESOP), which requires an independent appraisal every year.
Partners are buying each other out under a buy-sell agreement.
A divorce involves the business.
A buyer is financing the purchase and the lender requires an independent valuation, as SBA lenders generally do above certain loan amounts.
Valuation range: built for planning
A range looks at your earnings, how comparable businesses are selling, and what makes yours more or less attractive, and gives you a low, middle and high. It's faster and less expensive, and it's about the market, not the IRS. At RealDeal360, our free exit-readiness assessment ends with a readiness score and a rough valuation range, so owners have a starting point.
Buyers set the real price
What I wish I'd understood earlier: the actual price is set by buyers, not appraisers. A buyer who can fold your business into theirs might pay more than fair market value. A buyer who sees risk will pay less. A formal appraisal won't tell you that, and a range won't satisfy the IRS. Use the right tool for the question you're asking.
Timing matters if you plan to gift shares
If you're considering gifting shares or setting up a trust before a sale, a formal valuation done early, before the value jumps, is often part of the plan. Ask your CPA and estate attorney about timing. (See what to set up before you sell.)
One thing to try this week
Ask yourself why you want a number. If it's for planning, start with a range. If someone else has to rely on it, get a formal appraisal.
Related questions
What will the tax bill be when you sell, and when is it too late to change it?
Who would buy my business? Strategic, financial and individual buyers
This article is for general information only and is not tax, legal, investment or financial advice. RealDeal360 is not your attorney, accountant, tax advisor or investment advisor.