Determining the value of a business or an interest in a business is not a simple process. The American Institute of Certified Public Accountants has a specified educational curriculum for CPA's who want to receive certification in the specialty of evaluating businesses or interests in businesses. There are several different "accepted" approaches to such evaluations.
Approaches in evaluation range from (1) basing the value on the net equity section of the company's balance sheet after revising the assets to present fair market value, to (2) basing the value on formulas applied to likely future cash flow scenarios.
Usually, the value of a business is best determined by generating long term cash flow projections based upon past income and expense statements, with adjustments for reasonable assumptions into the future, and with reasonable salary and benefits for the owners. The "after tax income" of the business is what is available to amortize the purchase price, whether the transaction is financed by a bank or by the seller. The only questions left are how long does the buyer make the payments, and what is the interest rate on the borrowed funds. Even if the buyer has cash, he or she needs to compare what money invested in the business will generate as compared to what money invested in another investment vehicle will generate.
Hiring a qualified CPA to evaluate the business or business interest is money well spent whether you are the buyer or the seller.
Even if the seller is financing the transaction, setting the value too high will lead to financial difficulty for the buyer. Most likely, that will lead to late payments, which will result in the seller being required to retain an attorney to (1) force the buyer to make payments in a timely fashion or face a lawsuit, or (2) sue the buyer for return of the company or the selected assets purchased and for economic damages for the difference between what the seller sold the business or assets to the buyer for and what he or she is able to get in a sale to another party. Often, the business is not in as good of shape financially when it is returned as when it was sold. Consequently, the buyer has to spend time and money building the business up again to sell it for a good price again. A fair price in the beginning avoids those problems.
