Jan 24 2011

A Quick Guide to Business Appraisals

There is a lot of confusion out there about business appraisals.  And no wonder.  Many of the so-called “experts” are the ones doing the confusing.

So here is a quick guide to business appraisals for privately-held businesses.

There are two basic types of business appraisals: Compliance Appraisals and Market Appraisals.

Compliance Appraisals

Compliance appraisals are performed to comply with the law.  Typically tax law.  Compliance appraisals are required to calculate federal (and state) gift and estate taxes.  IRS Revenue Ruling 5960, established the concept of “fair market value”.  In practice, however, decades of court rulings and precedent have reduced the concept of fair market value to a series of “calculations” based on flawed assumptions, and consequently, have little to do with true market value.

Most certified public accountants and tax attorneys that provide business “valuation” services for their clients, are performing compliance appraisals.  While compliance appraisals are certainly necessary to comply with tax law, they are not to be confused with market appraisals.

Market Appraisals

Market appraisals are performed to determine the market value of a particular business to a hypothetical buyer, given a set of circumstances.

As mentioned earlier, the term “fair market value” has nothing to do with actual market value.  The only way to determine market value is to look at the market for similar businesses.  Similar to the way real property is valued, a market value appraisal of a business must look at comparable sales data, either individually or in aggregate, to properly estimate the market value of a subject company.

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So if you need to comply with the law, get a compliance appraisal.  If you want to know the value of your business, get a market appraisal…and by all means…hire a professional who knows the difference between the two.