A business valuation estimates what your company is worth to a willing buyer. Appraisers generally weigh three approaches, the business's earnings, sales of comparable businesses and the value of its assets, and they adjust your financial statements before applying any of them. If you are planning a sale or a transfer in the Phoenix Metro area, the most useful early step is getting your records in order, because every approach starts from them.
This article updates our January 2024 post on selling a business. That post also covered filing deadlines that have since passed, so this version keeps to valuation and the tax questions that come with a sale.
What does fair market value mean?
Most valuations for a sale or a tax filing aim at fair market value. The IRS describes it as the price that would be agreed on between a willing buyer and a willing seller, with neither required to act and both knowing the relevant facts. IRS Publication 561
A valuation prepared for a particular buyer, a dispute or a court may use a different standard of value. Ask the appraiser which standard the report uses and why.
How do appraisers value a small business?
The IRS business valuation guidelines name three generally accepted approaches: the asset-based approach, the market approach and the income approach. IRS Internal Revenue Manual 4.48.4
| Approach | The question it asks | Often most useful when |
|---|---|---|
| Income | What will the business earn for an owner? | Earnings are steady and the records are reliable |
| Market | What have similar businesses sold for? | Comparable sales can be found |
| Asset-based | What are the assets worth, less the debts? | The assets drive the value |
The same guidelines list the factors a valuation should weigh, including the nature and history of the business, the economic outlook for its industry, its book value and financial condition, its earning capacity and whether goodwill exists. IRS Internal Revenue Manual 4.48.4
What records will an appraiser ask for?
The guidelines also say historical financial statements should be analyzed and, where needed, adjusted so they reflect the business's actual assets, income and cash flow. IRS Internal Revenue Manual 4.48.4 Expect requests like these:
- Several years of income statements, balance sheets and business tax returns
- Owner pay and any personal expenses run through the business, so they can be adjusted
- How much revenue comes from your largest customers
- Leases, loans, equipment lists and contracts that would transfer with the business
- Sales of similar businesses in your area, if you know of any
Current, reconciled books make each of these faster to produce and easier for an appraiser to trust. The bookkeeping and accounting page describes that work.
When do you need a valuation?
- A sale or a new partner. A valuation gives you a supported number before you negotiate.
- A succession plan or buy-sell agreement. Owners often set how value will be measured before anyone leaves. The succession planning page covers the planning side.
- A gift of ownership or an estate plan. Gift and estate tax rules use fair market value, so the number needs support. IRS gift tax questions and answers
- A buyer's financing. If a buyer uses an SBA 7(a) loan, the lender follows SBA rules that can require an independent business valuation. SBA SOP 50 10
Which tax questions change what you keep?
Value and after-tax proceeds are different numbers. Two questions come up in most small business sales.
Is it an asset sale? When a group of assets that makes up a business is sold, both the buyer and the seller report how the price is allocated on Form 8594 if goodwill or going concern value attaches. How the price is split among the assets affects the tax on each part. IRS: About Form 8594
Will you be paid over time? If you receive at least one payment after the year of the sale, the installment method can spread the gain over the years you are paid. Depreciation recapture is still reported in the year of the sale. IRS Topic 705, installment sales
Both are worth modeling before you agree to terms. The tax planning page describes that work.
Who should do the valuation?
Use an appraiser who holds a recognized business valuation credential, and ask at the start which standard of value and which approaches the report will use. A lender or court may require a particular credential, so check before you hire.
Contact the office if you want your books and tax picture in order before an appraiser or a buyer looks at them.
Frequently asked questions
What is fair market value?
The IRS describes it as the price a willing buyer and a willing seller would agree on when neither has to act and both know the relevant facts.
Which valuation approach is right for my business?
It depends on the business and the reason for the valuation. Appraisers generally consider the income, market and asset-based approaches and explain which ones they relied on.
When does a business owner need a valuation?
Common reasons are a sale or a new partner, a succession plan or buy-sell agreement, a gift of ownership or estate plan, and a buyer's lender that requires one.
Sources
- IRS Publication 561, Determining the Value of Donated Property
- IRS Internal Revenue Manual 4.48.4, Business Valuation Guidelines
- IRS: About Form 8594, Asset Acquisition Statement
- IRS Topic 705, Installment sales
- IRS: frequently asked questions on gift taxes
- SBA SOP 50 10, Lender and Development Company Loan Programs
About the author
Craig L. Elggren, CPA, PC is a Gilbert accounting practice. This article explains how business valuations generally work as of September 2026; it is not an appraisal of any business.