Price vs. Value

valuation basics for transactions Jul 23, 2021

Understanding the Gap!

It is normal and natural that price and value perspectives differ between buyers and sellers.  A simple experiment shows what is happening and can help us understand what occurrs as the parties approach the transaction process.

An experiment was designed as follows: One group of students randomly selected was given a cup and another group was not.  The two groups were separated and not in contact with each other nor did they know what question each group was going to be asked.  The group without the cups were independently shown a cup and asked what price they would pay fo it.  The answers centered around $4.00.  The other group, who had the cups in their possess, were each separately asked what they would take to part (sell) with their cup.  These answers centered around $8.00.   

Many experiments of this nature have been repeated with similar results.  What is happening?  It is human nature to value something "in our possession" higher than the same thing we do not have.  Conversely, if we are going to "give up something" to acquire an item (i.e. pay cash which is in our possession) we value the cash we have higher and will place a lower price on the item offered for purchase.  Couple this basic human nature with decades of hard work building a business and it is no wonder that business owners often "over value" their businesses.   The extent of this variance between the seller's price and the underlying market value is important to determine.  If there is insufficient understanding of what is happening and how the business is valued in the market , then there will probably not be a transaction.

Valuation analysis that shows the value drivers, presents market comparisons and alternatives, and applies valuation methods in an easy to understand manner should help an business owner learn what the business is worth today and what is necessary to increase the value over time.  Pricing of any business prior to marketing should be reflective of this type of sound analysis.   Anything less will do a dis-service to the business as well as the owners and risks a failure during the marketing process.   An experienced transaction advisor will insist on this key valuation analysis step before putting a business on the market...even if the business is ultimately marketed, as most mid-sized business are today, without an "asking price". 

It should always be remembered:  As a buyer:  Price is what you pay and value is what you expect to receive.  Conversely, as a seller:  Price is what your receive and value is what you deliver.  Negotiation between well informed parties should result in the balance that the parties are seeking so that a transaction can be completed. 

At times buyers try to purchase a business at a "bargain" price.  In most case this is just as big a hurdle to completing a transaction as seller's significantly over-valuing their businesses.  Both parties should be prepared to pay for and deliver value at a price that refects the market place.  That is how "good" deals get done.