When valuing a business for sale, start by reviewing basic financial statements.
Example: A husband and wife have been working in his father’s small business for almost four years now. They would like to buy his small business from him. It is a independent copier/fax dealership located in a small town.
They know the market potential and that his accountant has taken advantage of all of the possible loop-holes to shelter him from taxes. This will be the first year that the financials will depict a (pretty close) picture of the company. How do they evaluate the company and gain a fair evaluation of what they should offer him for his company?
Two major financial statements should be reviewed with their accountant, the balance sheet and the statement of income and expense.
The Balance Sheet should show how the assets, liabilities and net worth of the business are valued. Items shown on the Balance Sheet may not tell the entire story. For example, is the equipment valued realistically? The equipment may be obsolete despite what is shown on the statement. Are the accounts receivable fully collectable? Also, the liabilities may not reflect contingent liabilities, such as a pending lawsuit or potential tax liabilities. These are just a few of the many questions you must ask to determine true value of a business.
Looking at the next important financial statement is the Statement of Income and Expense (also called the Profit and Loss Statement). Are the sales correctly reflected? Unfortunately, many businesses dealing with cash do not deposit all the sales receipts. If so, how can the seller prove the correct sales. Or, when anticipating selling the business, the sales may be overstated. The expenses may contain personal items that are not business related. The point I am trying to make is that you need an experienced CPA or business appraiser who represents your interests to represent you when buying a business.
In this example we may be dealing with a father who is trying to help his kids as fairly as he can. He may be willing to agree to terms that will not be a strain on their finances. We may also assume, that in retirement, he would like to have an ongoing income stream from the business. Since the business shows good prospects for the future I can envision structuring a deal that is beneficial to both of them. The idea is for the buyers to give as small a down payment as possible to afford them maximum working capital.
A percentage of the gross sales or net profits can be paid out to the father for a certain numbers of years. Using such a formula will enable him to benefit by any future growth in the business. To arrive at a total payout amount would, of course, require knowing a lot more information than is provided in this quick example.