A business valuation report is a document that estimates what a business is worth. When you are considering buying a business, a valuation gives you a structured way to assess whether the asking price is supported by what the business actually earns. Knowing how to read one and what to look for makes the difference between accepting a number and understanding it. Not all business valuations are created equal. The quality of the analysis, the credentials of the analyst, and the standards followed all affect how useful the report is for evaluating an acquisition.
Who Prepared the Valuation
The first thing to look for is who performed the work. Credentialed valuation professionals — those holding designations such as ABV (issued by the AICPA), CVA (issued by NACVA), ASA (issued by the American Society of Appraisers), or CBA (issued by NACVA) — follow enforceable professional standards for preparing a valuation. A report prepared by a credentialed analyst is built to be defensible, with sound reasoning andmethodology. A valuation prepared by the seller, the seller's broker, or another party with a financial interest in the sale is not independent and may only be used for reference.
The Purpose and Effective Date
A valuation report should state, clearly, what the valuation is for and when it was prepared. Business valuations are prepared for many different purposes — estate planning, divorce, tax filing, internal planning, transaction support — and each purpose may use a different standard of value. For an acquisition, the relevant standard is typically fair market value or investment value, depending on the context. For this reason, a valuation prepared for tax or estate purposes may not be applicable to a sale, even if it was prepared recently and competently.
The effective date matters because business performance changes. A valuation from twelve or eighteen months ago does not reflect the current state of the business. Look for a recent effective date, ideally within six months of when you are reviewing it.
The Standard of Value Used
The report should state which standard of value applies. The most common in acquisitions are:
- Fair market value. What a hypothetical willing buyer would pay a hypothetical willing seller, with both parties informed and neither under compulsion to act. This is the most common standard in transactional valuations.
- Investment value. What the business is worth to a specific buyer given their particular circumstances, typically with value added for potential synergies. These valuations are less common, particularly when financing is involved, as the valuation will rely on projections or potentially unsubstantiated adjustments to earnings..Knowing which standard the valuation uses tells you what the number actually means and whether it applies to your situation.
The Methodology
A credentialed valuation will apply one or more recognized approaches:
- The market approach uses sale prices of comparable businesses to derive a multiple (most commonly earnings) and applies it to the Company’s earnings.
- The income approach involves projecting out future earnings and discounting them to the present value.
- The asset approach values the business based on the fair market value of its assets minus its liabilities. This approach serves as a “value floor” in valuations, most commonly yielding an indicated value lower than the income and market approaches. The asset approach only comes into play when it yields a higher value than both of the other two approaches, at which point it will serve as the Final Value.
A well-prepared report explains which approaches were used and considered, and why. If a report uses only one approach without addressing the others, that limits how complete the analysis is.
The Earnings Basis
Most business valuations rely on some measure of earnings. The report should clearly define which measure is being used:
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) — common in mid-market and larger businesses.
- SDE (Seller's Discretionary Earnings) — common in small business valuations. Consists of EBITDA plus the compensation paid to the owner of the company.
- Net income — less common as the primary earnings measure in acquisitions but often referenced in analysis and calculations.
The earnings figure should be supported by the source financials. Adjustments made to earnings should be clearly identified with calculations and adjustments displayed.
The Multiples or Rates Applied
When the market approach is used, the report applies a multiple to the earnings figure. For small businesses, the most common source of market approach data is transaction databases, from which a “comp set” similar to the company will be derived.. Reports should explain how the comps were found, which is typically via filtering by an industry NAICS or SIC code and a sales filter (among other filters). The report should also state how the multiple is derived from this data set, which is typically by using a percentile deemed most similar to the company.
When the income approach is used, the appraiser applies a capitalization or discount rate to discount future earnings back to the present.. For small businesses, it is most common to derive a rate using the build-up method. This approach sums several components, sourcing a risk-free rate, equity risk premium, and typically premiums for industry, size, and company-specific risks. The calculation of the rate should be displayed with each component identified and sourced where applicable.
The Conclusion
The report should state a valuer or value range as a clear conclusion that is supported by sound methodology and analysis. Limiting conditions, assumptions, and the scope of the engagement should be clearly disclosed. A report that ends with a calculation but no stated conclusion, or one that presents a value without traceable reasoning, is harder to rely on. A clean conclusion lets you understand what the analyst is saying and why.
What This Means for You as a Buyer
A business valuation may not come back equal to the asking price. It is an independent estimate of what the business is worth based on its financials, market position, and the standards used. As a buyer, the value of a valuation is that it tells you whether the price you are being asked to pay is supported by something more than the seller's hopes.
