The Business Valuation Gap: Why Buyers and Sellers Disagree on Value

Summary:

• Valuation relies on judgment calls about add-backs, working capital, real estate, and risk premiums. That’s how two credentialed appraisers using the same data reached conclusions more than $1.1 million apart.
• Similar headline values can hide very different assumptions. In the case study, one appraiser’s generous balance sheet choices offset a much harsher view of key-person and customer concentration risk.
• Owners can narrow the gap years before a sale. The main steps are reconciling systems, documenting related-party compensation, appraising real estate, reducing founder dependence, and getting an independent valuation.

Two credentialed appraisers valued the same company. They used the same standard of value, the same two valuation approaches, and the same information from management. Both worked independently and in good faith, but their conclusions landed more than $1.1 million apart. 

Neither was necessarily wrong. That’s the business valuation gap, and it’s exactly what happens when a buyer and a seller sit down to negotiate. Each side looks at the same financial statements and reaches a different number. Usually no one is hiding anything. Valuation depends on judgment calls, and reasonable people make them differently. To show how this works, we’ll walk through a hypothetical company, the decisions that separated the two conclusions, and how each decision tends to play out at the deal table. 

Case study: One company, two valuations 

Apex Advisory Group, LLC, is a hypothetical engineering and infrastructure consulting firm in Chicago. John Smith founded it in 2006, and it serves municipal governments, utility companies, and private developers across the Midwest. John owns 80%, and his chief operating officer, Sarah Jones, owns 20%. The owners are considering an ownership transition, with a valuation date of December 31, 2026.

Fiscal year 2025

On paper, Apex looks like a clean, profitable, debt-free business. But management interviews surfaced five facts that complicate the picture: 

• Unbilled receivables: $850,000 in unbilled work sits in the project management software but not in the accounting records. 

• Real estate: The headquarters building is carried at its 2010 purchase cost and has never been appraised. 

• Related-party compensation: John’s daughter serves as marketing director at $220,000 per year. Estimated market pay for the role is $90,000. 

• Customer concentration: The largest customer accounts for 28% of revenue, and the top five account for 62%. 

• Key-person dependence: John personally originates about 80% of new business, and he has no employment agreement or non-compete. 

What is fair market value, and why does it leave room for judgment? 

Both appraisers applied fair market value (FMV), the standard the IRS uses for tax valuations. Revenue Ruling 59-60 defines it as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” 

That definition tells you who the parties are. It doesn’t tell you how to treat an unreconciled receivable or how much risk a founder-dependent business carries. Those decisions are left to the appraiser and, in a real transaction, to the negotiation.

Key assumptions behind the valuation gap

Owner compensation: How add-backs change normalized EBITDA 

The case for adjusting to market ($130,000): The business needs someone doing marketing. A buyer would still have to fill the role, so only the pay above the $90,000 market rate is an owner benefit. 

The case for adding back the full salary ($220,000): The role wasn’t filled through an arm’s-length process, and there’s no evidence a buyer would keep it. If the position exists because of a family relationship, the whole salary is discretionary. 

At the deal table: Sellers push for the larger add-back because every dollar of normalized EBITDA is multiplied. At Appraiser A’s 6.0x multiple, the $90,000 difference is worth $540,000. Buyers will ask for job descriptions, performance history, and market compensation data. If the documentation isn’t there, expect a smaller number. 

Balance sheet adjustments: Receivables, working capital, and real estate 

Unbilled receivables. One view is that an asset management system that can’t reconcile to the general ledger isn’t an asset anyone can rely on, and a buyer’s diligence team would reach the same conclusion. The other view is that these are earned revenues for completed work, and the fact that they live in a separate system is a bookkeeping problem rather than an economic one. At the deal table, the seller wants to count the $850,000. The buyer wants it reconciled before paying for it. 

Working capital. Appraiser A used Apex’s own historical working capital as the benchmark: observed history over a database figure that may reflect different billing cycles and contract structures. Appraiser B countered that history describes what the company held, not what it needs. A business that hasn’t distributed earnings for years will look like it requires more working capital than it does. The lower 15% requirement leaves more “excess” working capital that gets added to value, which is why sellers favor it, and buyers resist it. In this case, the working capital assumption alone moved value by nearly $1.5 million (about $950,000 of excess working capital for Appraiser A versus about $2.4 million for Appraiser B). 

Real estate. Appraiser A treated the building as an operating asset whose book value is a reasonable proxy, and viewed an appraisal as an expense with limited payoff. Appraiser B’s position was that a 2010 purchase price is an accounting convention, not an opinion of value, and that Chicago commercial real estate has moved considerably since then. The appraisal added $1.5 million. Sellers will want that value recognized. Buyers may prefer to exclude the building entirely and lease it or finance it separately. 

Discount rates: How key-person risk and customer concentration affect value 

Appraiser A used a 19.0% weighted average cost of capital. Appraiser B used 22.5%, driven by a higher size premium and a higher company-specific risk premium. 

The case for the lower rate: Apex has nearly 20 years of profitable history, no debt, strong margins, and a diversified professional staff. A cost of capital near 20% already prices in substantial risk for a business this size. Adding more without specific, identifiable risk factors penalizes the company for being small. 

The case for the higher rate: The risk factors are specific and identifiable. One person originates 80% of new business without an employment agreement or non-compete. One customer is 28% of revenue with no contractual protection disclosed. A general size premium doesn’t capture those facts. 

At the deal table: This is where buyers spend most of their energy. A seller sees 20 years of stability. A buyer sees a pipeline that may leave with the founder. Discount rates are hard to negotiate directly, so buyers usually express this concern through price, earnouts, or required transition agreements. 

Market approach: Public company comparables vs. private transactions 

Appraiser A applied a 6.0x EBITDA multiple drawn from publicly traded companies with $500 million to $1.2 billion in revenue, adjusted for size, risk, and growth as of the valuation date. Appraiser B applied 5.0x, drawn from private transactions of smaller firms in 2013, 2020, and 2021. 

The case for public comparables: Companies the size of Apex don’t go public, so the method requires adjusting data from larger companies. Public data is transparent and current, and a stale private deal from a different market may be less reliable than an adjusted current one. 

The case for private transactions: Firms 50 to 100 times larger have institutional management, diversified clients, and access to capital markets. Apex’s buyer isn’t competing with buyers of large public firms, and private deals reflect the market Apex would sell into. 

Both criticisms land. Appraiser A’s comparables are far larger than Apex. Appraiser B’s are several years old, and a 2013 transaction was priced in a very different market. This is typical of lower middle-market valuations: there is rarely a perfect comparable, only a trade-off between relevance and timeliness. 

How do appraisers weigh the income and market approaches? 

Appraiser A’s two approaches were about $780,000 apart, and that convergence supported equal weighting. Appraiser B’s were nearly $4 million apart. B read the spread as a signal: the market approach reflects a generic, stabilized business, while the discounted cash flow (DCF) analysis reflects this specific company, with this owner and these customers. B therefore gave the income approach 75% of the weight. 

Why similar valuations can hide very different assumptions 

The concluded values differ by a little over $1.1 million. The individual assumptions differ by much more. 

Appraiser B took a more generous view of the balance sheet by including the unbilled receivables, using a lower working capital requirement, and appraising the real estate. Together, those choices added nearly $3 million of value beyond Appraiser A’s figures. That’s why B’s market approach, at $15.4 million, was the highest single indication in the entire analysis. It was driven by real estate and working capital, not by earning power. 

Appraiser B also took the harsher view of risk. B’s income approach valued the operating business at $6.65 million, compared with $11.4 million for Appraiser A, a difference of $4.75 million. 

The two effects partly offset each other. That’s an important lesson for any owner reviewing a valuation or an offer: two numbers that look close can rest on very different beliefs about the business. And a buyer and seller who agree on a headline price may still be far apart on the assumptions underneath it, which tends to surface later in diligence or in deal terms. 

Personal vs. enterprise goodwill: Why founder dependence matters 

The same facts also produce different views on goodwill. Appraiser A saw mostly enterprise goodwill: 42 professionals, a long operating history, established systems and client relationships, and a chief operating officer who runs day-to-day operations. Appraiser B saw significant personal goodwill: if John leaves with 80% of new business origination and no non-compete, the buyer has acquired a staff and a building without a pipeline. 

The split between personal and enterprise goodwill carries the most weight in certain contexts, such as marital dissolution. In a sale, it shows up in how a buyer structures the deal. A buyer who believes the value follows the founder will often want the founder bound by an employment agreement, a non-compete, or an earnout tied to future results. 

How to narrow the valuation gap before you sell your business 

Most of the disagreement in this case traces back to issues an owner can address years before a sale: 

• Reconcile your systems. If revenue or receivables live outside the general ledger, tie them together now. An asset you can’t document is an asset a buyer will discount. 

• Document related-party compensation. Keep job descriptions, performance reviews, and market pay data for family members on the payroll. Add-backs without support are among the first a buyer rejects. 

• Know what your real estate is worth. Decide whether the building is part of the deal. If it is, an appraisal gives you evidence instead of an argument. 

• Reduce key-person dependence. Transition client relationships to other leaders and formalize agreements with key people. This is often the single largest driver of risk in a founder-led business. 

• Address customer concentration. Diversify where you can, and put contractual protections in place with your largest customers. 

• Get a valuation before a buyer does. An independent valuation shows you where the judgment calls are and which ones a buyer is likely to challenge, while you still have time to act. 

A buyer and a seller will rarely see value the same way. The goal isn’t to eliminate every difference. It’s to make sure the facts supporting your number are documented well enough that the difference stays small. 

If you’re considering a sale, a buyout, or an ownership transition, please reach out. We’re happy to walk through how these issues apply to your business.