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The topic of business evaluation is so complex that any explanation short of
an entire book does not do it justice. The process takes into account many,
many variables and requires that a number of assumptions be made. Shannon
Pratt, a noted business valuation expert, names six of the most important
factors:
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Recent profit history.
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General condition of the company (such as condition of facilities,
completeness and accuracy of books and records, morale and so on).
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Market demand for the particular type of business.
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Economic conditions (especially cost and availability of capital and any
economic factors that directly affect the business).
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Ability to transfer goodwill or other intangible values to a new owner.
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Future profit potential.
The six factors named above determine the fair market value. However,
businesses rarely change hands at fair market value. The reason is that
three other factors often come into play in arriving at an agreed upon
price. Pratt identifies them as follows:
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Special circumstances of the particular buyer and seller.
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Tradeoff between cash and terms.
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Relative tax consequences for the buyer and seller, which depend on how
the transaction is structured.
The definition of fair market value is the price at which property would
change hands between a willing buyer and a willing seller, both being
adequately informed of all material facts and neither being compelled to buy
or to sell. In the market place, buyer and seller are nearly always acting
under different levels of compulsion.
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