Those who have looked at buying a business before may have found that their accountant’s valuations are well below the asking price. The asking price can often exceed its fair value for the following reasons:
- Price and value are not the same thing.
A valuer typically values a business on the basis of a willing buyer and a willing seller. Since perfect market conditions often do not exist, the seller may be more willing to sell or a buyer more willing to buy at particular points in time.
Price is therefore the outcome of what indications there are of a potential transaction. For example, if a buyer sees strong value in a business then they may be prepared to pay a price premium to ensure they can secure it. Conversely, if the business has been unable to sell for a while and the vendor needs cash, then they may reduce the asking price to stimulate a sale. - Price can reflect the volume of business opportunities for sale. Basic economic theory will dictate that a higher demand for a particular type of business will increase the price paid for it. Likewise, if there is a limited supply for a particular type of business then it is likely to trade at a price premium compared to its value.
- The initial price might be listed at a 10% to 20% premium in order to allow room for negotiation. This is a common tactic and it results in very few transactions being completed at the original price.
The factors described above explains why it is common to witness a gap between the price and valuation of a business.
Management Advisors Pty Ltd is a highly sought after independent financial services firm and boutiqe investment bank. Their team has extensive experience in initiating, sourcing and negotiating M&A transactions to completion.