How do you know what a business is worth? How do you not get ripped off? Here are some suggestions. The best way, from your perspective, to buy a business is to buy “assets only” of a business that you have studied the market for, and you can see potential for. It would be rare to find such a deal. If you are buying a business that is in financial trouble, you definitely may want an assets-only deal, after all, why would you want to buy obligations or lawsuits? Many times a seller has unrealistic expectations, is looking for a bail out, and you should be able to get the assets at a bargain, if the seller faces reality. If they need bailed out, that’s their problem, not yours. Do not buy a business from someone who puffs up what the “potential” is. If there was potential, he’d have done it. And never pay for potential that YOU are going to develop. Why would you pay them for potential that you are going to bring out?
If the business you want to buy is a “going-concern”, healthy, making money, why are they selling? Is the owner retiring? You need to understand what the real reason is. If he/she is retiring, will they “carry the paper” or finance and let you pay them over time? This, in fact, might be preferable to a lump sum for them, so ask. You also need to ascertain if the owner makes a salary AND no profit, in other words, are you simply buying a job? Don’t buy a job. A business must pay you for your work AND a reasonable profit for having taken on the risk of business, otherwise, there’s no point. You can earn money risk-free just having it sit in the bank, if you’re going to take a risk, that is worth a premium.
Anyway, for a going, healthy business, you might arrive at a number that is a multiple of the earnings of the business, typically in the neighborhood of 5 times net income from operations (no depreciation, interest, taxes) or 2 times gross income for a service business. Check with your CPA to get industry-specific standard numbers.
A final tip: ask for the recent tax returns of the seller. No one in their right mind overpays on their taxes, so this is the best indicator of the real income coming from the business.