What's The Difference Between Price & Value?
You are looking to buy a small business. You see something you are interested in: right industry, right location but is it the right price? In today’s market everyone is looking for a bargain. The difficulty in assessing the price of a small business is that there may not be a lot of ready comparisons available in the market. If you are looking to buy a business where there is a large and active market - like a newsagency, pharmacy or coffee lounge - then comparisons will be available. And, there are industry models that typically set the pricing for these types of business. However, if you are looking at a more unique business where there is not a lot of public information, the going can get tougher.
If you need an opinion on price, be careful and make sure you get the information you are really after.
When you value a small business it is not unusual for the valuation to come in under the asking price. A normal reaction to this is that the business must be overpriced. While this is sometimes true it is not automatically the case. In a perfect market, price and value are the same thing - but we don’t operate in a perfect market. As a result, this causes price to trade at either a premium or a discount to value. Over the past decade in Australia, price has traded at a premium of up to 30% on value for good quality businesses. To test the price of a business, you need to understand both its value and also any information on the price that businesses of the type you are looking at have traded for in the market.
When you ask for a valuation of a prospective business, the real question you might be seeking an answer to is should I buy this business? This is a very different question to one about valuation. Should I buy this business is about a range of both financial and non-financial indicators. It is as much about whether the business suits your lifestyle expectations and core capabilities as it is about the financial performance. If the business is a growth business and needs lots of marketing push, then it will not suit you unless you like the marketing aspect and have the time to dedicate to it. To assess all of this you need to understand the business and the business model in operation. You then need to compare the model to your expectations and also your business strengths. None of us are good everything. You need a business that matches your strengths.
You don’t want to pay too much for the business but equally you don’t want to miss out on the right business because the asking price is a bit more than you expected or what someone has told you it’s worth. Whether or not you are prepared to pay a premium to value will depend on how much you want the business and what growth you can see in it. Good quality businesses with good growth prospects will almost always command a premium as there are always buyers for these types of businesses. Understanding the true value of a business, is understanding what it is worth now and also what value you can add to it. Once you know both these numbers you should be ready to negotiate on price.