Quick answer: Valuers estimate what a private company is worth using three families of approach. The income approach converts expected earnings or cash flow into a present value. The market approach infers value from prices paid for comparable companies or transactions. The asset approach adds up the value of what the company owns and subtracts what it owes. Most valuations use more than one and reconcile the results, giving the most weight to the approach that fits the company and the data best.
Key points
- Approach is the family and method is the technique inside it. Capitalization of earnings and discounted cash flow are both income methods. Guideline public company and guideline transaction are both market methods.
- Operating businesses with steady earnings are mostly valued with the income and market approaches. The asset approach is the main tool for holding companies, asset-heavy businesses and businesses that do not earn an adequate return.
- Each approach rests on assumptions, such as the discount rate, the growth rate, the comparability of peers or the quality of the balance sheet. A small change in a key assumption can move the answer a long way.
- A transactional valuation leans on market evidence, meaning how buyers are likely to price the business, and uses the income and asset analyses to test whether the answer is reasonable.
Approaches and methods
Valuation vocabulary has two levels, and keeping them apart makes everything else easier to follow. An approach is a general way of reasoning about value. A method is a specific technique within an approach. There are three approaches, and each answers a different question.
| Approach | The question it answers | Common methods | Best suited to | Main limitation |
|---|---|---|---|---|
| Income | What are the future earnings or cash flows worth today? | Capitalization of earnings, discounted cash flow | Established businesses with a track record and predictable earnings | Sensitive to the discount rate and the forecast |
| Market | What are buyers paying for similar businesses? | Guideline public companies, guideline transactions | Businesses with comparable peers and available data | Comparable evidence is thin for small private companies |
| Asset | What would it cost to own what the company holds? | Adjusted net asset value, liquidation value | Holding companies, asset-heavy businesses, businesses earning poor returns | Understates the value of a business with strong earnings |
The income approach
The income approach starts from the idea that a business is worth the earnings it will produce, adjusted for how risky and how distant those earnings are. Two methods are common.
Capitalization of earnings. The valuer takes a single level of normalized earnings or cash flow and divides it by a capitalization rate. The rate reflects the return an investor requires, less the growth expected after the first period. This method suits a business whose earnings are stable and expected to grow at a steady pace. The earnings figure matters as much as the rate, which is why normalizing EBITDA is the first step in most private company valuations.
Discounted cash flow. The valuer forecasts cash flows for several years, estimates the value of the business at the end of the forecast period, and discounts everything to a present value at a rate that reflects risk. It suits businesses that are changing, such as those with fast growth, new contracts or planned investment, where a single level of earnings does not represent the future.
The discount rate is the delicate part. It is usually built up from the return on low-risk investments, the extra return investors demand for owning equity, an allowance for the smaller size and illiquidity of the company, and an allowance for risks specific to the business. Each layer is a judgment. The IRS’s reference material calls the choice of a capitalization rate one of the hardest problems in valuation,[1] and that is why a valuation that shows its rate and the reasons for it can be tested, while one that does not cannot.
Illustrative example: How sensitive the answer is to the rate
A company has normalized cash flow of $2,000,000 and expects it to grow slowly. A valuer capitalizes it at a net rate of 17 percent, which gives a value of $11,764,706. A buyer who sees more risk and uses 20 percent arrives at $10,000,000. A buyer who sees less risk and uses 15 percent arrives at $13,333,333. A five-point spread in the rate moves the value by more than $3,300,000, and the earnings did not change. The rates are invented to show the sensitivity and are not benchmarks.
The market approach
The market approach starts from what others have paid. If similar businesses are priced at a certain multiple of earnings, the valuer applies a multiple, adjusted for differences, to the subject company’s earnings. Three sources are used.
Guideline public companies. The multiples of listed companies in the same line of business. The IRS’s reference material describes prices of comparable listed companies as the next-best measure when the stock of the subject company is closely held.[1] The data is plentiful, but the companies are larger and more liquid than most private ones, so adjustment is required. The guide to valuation multiples shows how wide the spread across industries can be.
Guideline transactions. Prices paid for whole private companies. This is the closest evidence to a real sale, but the data comes from commercial databases that capture only some transactions and rarely disclose full terms, so it is thin for any particular size and sector.
Prior sales of the company’s own stock. If the company or its owners sold shares recently, the price is relevant, provided the sale was between unrelated parties at arm’s length. The same reference material says such sales should be examined for that.[1]
The market approach is the most intuitive, because it mirrors how a buyer thinks. Its weakness is comparability: no two businesses are alike, and the valuer must explain why the chosen peers resemble the subject.
The asset approach
The asset approach values a company as the sum of its parts. The valuer restates each asset and liability from book value to current value, including assets not on the balance sheet such as brand, customer relationships and technology, then subtracts liabilities to reach the value of the equity. When a business is failing or being wound down, liquidation value, the net amount obtainable from selling the assets, sets the floor.
For a business that earns a strong return on the assets it uses, the asset approach produces a value below what the earnings justify, because it does not capture goodwill. It is the main method for companies whose value lies in the assets themselves, such as holding companies, real estate vehicles and capital-intensive businesses with weak returns, and a useful floor for others.
Reconciling the results
When a valuation uses more than one method, the results rarely match. The task is to understand why they differ, and then to decide which is most reliable for the company at hand. The questions that settle this are practical.
- Which method has the best data? A market approach built on strong comparables deserves more weight than one built on stretched ones.
- Which method fits the business? A steady, mature business suits capitalization. A company in transition suits discounted cash flow.
- What would a buyer rely on? In a sale, buyers think in multiples of normalized earnings, so market evidence carries weight.
- Do the results cross-check? A discounted cash flow value can be restated as an implied multiple of EBITDA. If the implied multiple is far outside what buyers pay, one of the inputs deserves a second look.
Averaging the answers mechanically is the weakest option. The IRS’s reference material states that there is no sound basis for assigning mathematical weights to the factors and that they are to be brought together by judgment.[1] A valuer should therefore show the reasoning behind the final figure and not only the figure.
How the methods relate to a transactional valuation
A formal appraisal applies these approaches under professional standards for a defined purpose such as tax reporting. A transactional valuation addresses a different question: what are buyers likely to pay, in what form, and what would the owner net? It draws on the same tools but gives the most weight to market evidence and the structure of deals, and it uses the income and asset analyses as tests of reasonableness. The overview of transactional valuation and the comparison with appraisals explain when each is the right choice. Where the valuation is for a partial interest, the guide to discounts and premiums covers the adjustments that apply after the value of the whole is determined.
Frequently asked questions
Which valuation method is the most accurate?
None is accurate in itself. The right one depends on the company, the purpose and the data available. The IRS’s reference material for its valuation staff says there is no sound basis for mechanically averaging the factors that go into a valuation and that the information should be brought together through professional judgment.[1] That is why valuers use more than one method and explain the reconciliation.
What is a capitalization rate?
It is the rate of return a buyer requires on the earnings it is buying, applied to a single level of normalized earnings to produce a value. The relationship is inverse: the higher the rate, the lower the value. A capitalization rate is also the reciprocal of an earnings multiple, so the two are two ways to express the same price.
Is discounted cash flow better than using a multiple?
Neither is better in every case. A discounted cash flow model lets the valuer reflect expected growth, changing margins and investment needs, and it is only as good as the forecast and the discount rate. A multiple reflects what the market is paying for similar businesses, and it is only as good as the comparability of the evidence. Using both lets each test the other.
When is the asset approach used for a profitable company?
Rarely as the main method. The IRS’s reference material notes that adjusted net worth deserves more weight for investment or real estate holding companies than for operating companies.[1] For an operating business with healthy earnings, the asset approach more often serves as a floor or a cross-check.
Need a valuation you can use in a sale or acquisition decision?
The Impetus Group prepares transactional valuations from the standpoint of strategic and financial buyers. A valuation is a standalone engagement with its own scope and fee, and it can be the first step before a sale or acquisition process.
Related guides
- Valuation Multiples Explained: EV/EBITDA, EV/Revenue and More: What valuation multiples are, how EV/EBITDA, EV/revenue and EV/EBIT work, what drives a higher or lower multiple, and how to use public data with care.
- EBITDA Add-Backs: What Buyers Accept and What They Reject: Learn which EBITDA add-backs buyers accept in a sale, which they reject, and how adjusted EBITDA changes enterprise value, with a worked illustration.
- Transactional Valuation: What It Is and How It Works: A transactional valuation estimates what a strategic or financial buyer would pay for a business. Learn what goes into one and how it differs from an appraisal.
- Discounts and Premiums in Business Valuation: Control, Minority and Marketability: Control premiums, minority discounts and the discount for lack of marketability explained: what each adjusts for, how they stack and when they apply.
- Transactional Valuation vs. Appraisal: Which Do You Need?: A transactional valuation estimates what a buyer would pay. An appraisal estimates value under a legal or tax standard. See how they differ and which one fits.
- From Enterprise Value to Equity Value: What the Owner Receives: Enterprise value is the price of the business. Equity value is what owners receive after debt, debt-like items, cash and working capital. See the bridge.
Sources
- S Corporation Valuation Job Aid for IRS Valuation Professionals (reference only, not an official IRS position). Internal Revenue Service. Accessed October 8, 2026.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.