The agreement's own valuation clause controls, if the partners wrote one: a buy-sell agreement or an exit clause that names a formula, an appraiser, or a fixed figure the owners update each year is the number, and this page is not needed to pick one. It is needed for two other situations: no agreement exists, or one exists but nobody has priced the business under it in years and the figure needs checking before anyone signs. In either case, three approaches do essentially all the work appraisers do, and the hard part is not the arithmetic, which is simple, but picking the approach, and the multiple or discount rate inside it, that actually fits a small business with one or two owners and no public market for its shares.
The three approaches
Asset, income and market approaches compared
| Approach | What it measures | Fits best when | Main weakness for a small business |
|---|---|---|---|
| Asset approach | The fair market value of what the business owns, minus what it owes | The business has little goodwill and its value is mostly in equipment, inventory or real estate | Misses the value of customer relationships, a trained staff, or a lease on good terms, so it tends to undervalue a profitable, people-dependent business |
| Income (capitalized earnings) approach | A multiple of a normalized earnings figure, usually seller's discretionary earnings (SDE) for a one-owner-operated business or EBITDA for a larger one | The business has a track record of profit and the owner's own pay can be added back to get a clean earnings figure | The multiple is a judgment call, and a single bad or unusually good year can swing it if earnings are not normalized carefully |
| Market approach | What similar businesses have actually sold for, as a multiple of revenue or earnings | Enough comparable sales exist in the same trade and region to be meaningful | Few truly comparable small-business sales are public; the data is thinner than for real estate or public stock |
Most appraisals of a small, closely held business lean on the income approach, often checked against the market approach as a sanity check, with the asset approach as a floor: a business is rarely worth less than what it would fetch piece by piece, after paying off its debts.
Fair value and fair market value are not the same number
"Fair market value" asks what a hypothetical willing buyer would pay a hypothetical willing seller, neither one under pressure, both reasonably informed. It is the standard the asset, income and market approaches above are built to estimate, and the one most buy-sell agreements name.
"Fair value" is a different, narrower legal standard some states use specifically for a court-ordered buyout, and it does not always allow the same discounts a fair-market-value appraisal would: a minority discount (for owning less than control) or a marketability discount (for there being no ready market to sell into) are common in an ordinary appraisal, but several courts applying a fair-value standard in an oppression or dissolution case have refused to apply them, reasoning that doing so lets the people in control profit from freezing out the one being bought out. Which standard applies, which discounts survive it, and whether the price is set by a court or an appraisal panel is a question of state law and of whether the case is a straightforward dissociation buyout or a dissolution or oppression proceeding; the reference table of judicial dissolution grounds by state has where several of the largest states land on the buyout mechanism itself. Without an agreement, the Uniform Partnership Act (1997) sets its own default, the greater of liquidation value or going-concern value as of the date of dissociation (section 701(b)), which is closer to fair market value than to a discount-free fair-value standard.
A worked example
Valuing a hypothetical $400,000-SDE business three ways
Say a two-owner service business shows seller's discretionary earnings of $400,000 for the trailing twelve months, after adding back both owners' pay and a few personal expenses the books had carried. Its equipment and working capital, net of debt, would fetch roughly $180,000 sold piece by piece. Recent sales of similar firms in the trade have gone for around 2.5 times SDE.
| Asset approach: net assets at liquidation value | $180,000 |
|---|---|
| Income approach: $400,000 SDE times an assumed multiple of 2.8 | $1,120,000 |
| Market approach: $400,000 SDE times the comparable-sale multiple of 2.5 | $1,000,000 |
| A blended figure, weighting the income and market approaches equally and setting the asset approach as a floor | about $1,060,000 |
The three approaches land within about 12% of each other here, which is a reasonably tight spread; a wider one is common and is usually a sign the multiple or the normalization of earnings needs another look, not that one approach is simply wrong. The asset approach's $180,000 is a useful floor, confirming the business is worth far more as a going concern than broken up, but it answers a different question than what a buyer would actually pay for it.
Who does the appraisal, and what to ask before choosing one
Before hiring a business appraiser
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Ask for a credential: the common ones are ASA (Accredited Senior Appraiser, American Society of Appraisers), ABV (Accredited in Business Valuation, AICPA, for a CPA) and CVA (Certified Valuation Analyst, NACVA)
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Ask whether the engagement will be a full valuation report or a calculation of value, which costs less but carries less weight if the figure is later disputed
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Confirm which standard the appraiser will use, fair market value or fair value, and whether minority and marketability discounts will be applied or excluded, before the work starts rather than after
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Ask for the valuation date to be fixed up front (the date of the triggering event, under most buy-sell agreements, not the date the report is finished)
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Get the fee and the turnaround time in writing; both vary enough by region and by the complexity of the business that a figure here would not be a fact, only a guess
Once a figure is agreed, how to buy out a business partner covers structuring the actual purchase, including financing it when the number is larger than the cash on hand.
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