The purchase of a business is likely the most significant financial commitment a person will make in their lifetime, next to their home.  The first thing a buyer must do is acknowledge that the purchase you are considering is an investment, so remain objective and keep your emotions out of it.  Every buyer experiences strong emotions which blur their objectivity, causing them to overlook key issues or disregard apparent problems as unimportant.  This lack of objectivity leads to poor decisions, and years of heartache that you cannot easily exit.

The second thing a buyer must do is ensure you don’t overpay for the business.  Since you are buying an investment, you should never pay more than market value.  Market value for most small businesses is the price that is supported by the cash flow created by the business after taxes that will pay the business off within five years.  The reason you consider after tax cash flow is that you will be purchasing this business with after tax dollars.  If the price you arrive at is not supported by the cash flow you generate from the asset as is, then you may be paying too much.

Finally, buyers should not pay the seller for any value that will be added by the buyer.  For example, if the buyer plans to incorporate the new business into their existing business and reduce overhead costs, then the additional value created belongs to the buyer, not the seller.  The buyer should not expect to pay for the additional cash flow generated from the buyer’s actions.

Stay objective and remember the business is an investment.  After tax cash flow must support the purchase price, and make sure the buyer receives a return for their efforts in the process.