Quick answer: Business valuation is the formal process of determining what a company is worth. It's used when selling a business, establishing buy-sell agreement pricing, estate planning, SBA loan applications, divorce proceedings, and gifting equity. There are three main approaches: income-based (capitalizing or discounting earnings), market-based (comparable transaction multiples), and asset-based (net asset value). Most small business valuations combine methods, with income-based approaches carrying the most weight.
The Three Standard Valuation Approaches
The income approach converts expected future earnings into present value. The most common version for small businesses is the capitalization of earnings method: normalize owner compensation to market, add back personal expenses, calculate seller's discretionary earnings (SDE), then apply a capitalization rate or multiple. The market approach uses databases of actual business sale transactions (BizBuySell, DealStats, IBA Market Data) to find comparable sold businesses and apply their SDE or EBITDA multiples. The asset approach calculates the fair market value of all assets minus liabilities — most relevant for capital-intensive businesses or liquidation scenarios. For service and professional businesses, the income approach dominates.
Who Performs the Valuation and Why It Matters
Credentialed business valuation professionals hold designations such as CVA (Certified Valuation Analyst), ABV (Accredited in Business Valuation), ASA (Accredited Senior Appraiser), or CEPA (Certified Exit Planning Advisor). For IRS or legal purposes (estate planning, gifting, divorce), a formal valuation report from a credentialed analyst is required — informal estimates won't hold up. For buy-sell agreements, the agreement should specify the valuation method and who performs it (an agreed-upon third party, or a formula). A ballpark self-assessment using BizBuySell transaction data is fine for planning purposes — but get a professional opinion before any transaction closes.
What Business Owners Can Do to Increase Value Before Sale
Value is maximized by: reducing owner dependence (documented systems, capable management team), diversifying customer concentration (no single customer over 15% of revenue), recurring revenue (subscriptions, retainers, contracts), clean financials with 3 years of increasing profitability, and protecting intellectual property. Each of these factors increases the multiple a buyer will pay. A business selling at 3x SDE versus 5x SDE on $500,000 of earnings is a $1,000,000 difference in your pocket. Working with a financial advisor and exit planning specialist 3–5 years before your intended exit gives time to make meaningful value improvements.
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