What a Closely Held Business Is Worth: Valuation Basics

Why valuation matters

Value is the hinge of business succession. The estate tax is charged on the fair market value of the business interest at death; a lifetime gift of shares is measured the same way; a buy-sell price should reflect it; and fairness among heirs depends on it. Get the number wrong — too high and the estate overpays tax, too low and the IRS can challenge it — and everything built on top wobbles. Because so much rides on it, valuation for tax is a job for a qualified appraiser, not a rule of thumb.

The fair-market-value standard

Tax valuation uses fair market value: the price at which the interest would change hands between a willing buyer and a willing seller, neither under compulsion and both reasonably informed (IRC § 2031; Treas. Reg. § 20.2031-1). It is a hypothetical, market-based standard — not what the asset is worth to a particular family member, and not its book value on the balance sheet.

The Rev. Rul. 59-60 factors

The foundational guidance on valuing closely held stock is Revenue Ruling 59-60, still cited more than sixty years later. It directs an appraiser to weigh a defined set of factors, including:

• the nature and history of the business;
• the economic outlook, generally and for the specific industry;
• the book value and financial condition of the company;
• its earning capacity and its dividend-paying capacity;
• whether the business has goodwill or other intangible value;
• prior sales of the stock and the size of the block being valued; and
• the market price of comparable publicly traded companies.

No single factor controls; Rev. Rul. 59-60 calls for judgment, weighing them together for the particular company. That is why valuation is an opinion supported by analysis, not a formula.

The three approaches

Appraisers organize that judgment into three recognized approaches, often using more than one and reconciling the results:

• Asset approach — value the company’s net assets (assets minus liabilities), adjusted to fair value. Most relevant for asset-heavy or holding companies.
• Income approach — value the business on its ability to generate future earnings or cash flow, by capitalizing earnings or discounting projected cash flows. Most relevant for profitable operating companies.
• Market approach — value by comparison to sales of similar businesses or the trading multiples of comparable public companies.

Marketability and minority discounts

Two adjustments frequently lower the value of a private interest, and both are grounded in economic reality:

• Discount for lack of marketability. A private-company interest cannot be sold quickly on an exchange, so a buyer pays less for it than for otherwise-identical liquid stock.
• Minority (lack-of-control) discount. An interest that cannot control the company — cannot set salaries, force distributions, or direct a sale — is worth proportionally less than a controlling stake.

Sources & methodology