9032 / What types of external risks are important in determining the value of a small business?
As in any other business context, the value of a small business may be substantially impacted by external pressures and risk factors. As such, the IRS recognizes that the general economic outlook and industry-specific risk factors must be considered in determining the overall value of the business.1
In this analysis, it is important to identify industry trends that have emerged, and whether the business’ management is aware of these trends and planning to take advantage of them in their future business plans. While general economic outlook is an important consideration in assigning value to a business, the parties must also consider whether the small business in question tends to prosper in proportion to general economic conditions, or whether its performance is counter-cyclical. If the business’ performance is counter-cyclical, valuation must account for the fact that a general market downturn could represent a period of growth within the industry that the business operates.
Investor perceptions toward the industry in which the business operates can also serve as a predictor of current and future business value. To this end, examination of comparable businesses that are traded more regularly can aid in determining the potential for increased value in the small business based on industry performance. The IRS, therefore, recognizes that the market prices of stock in corporations engaged in the same or similar lines of business with actively traded stock, either on an exchange or over-the-counter, can be important in determining investor perceptions that can influence future value.2