Based in Sydney, Australia, Foundry is a blog by Rebecca Thao. Her posts explore modern architecture through photos and quotes by influential architects, engineers, and artists.

Business Value & Price

Appraising business value is a daily part of the work of a broker. It is fundamental in assisting business owners in their decision-making processes. The more attention paid to thorough and appropriate appraisal processes by brokers, the better.

One aspect of the appraisal process that is important to understand is the weighting which “comparable sales” should be given in imperfect market situations in determining appraised value.

In this article, I’d like to focus in on this particular aspect of the process. It is critical to a proper understanding of appraising business value.

The International Valuation Standards Council (IVSC) defines Market Value as “the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.

This definition has an implied term assuming that the market for a business approaches a perfect market.

To put this in perspective, I recently sold a 2007 Toyota Estima and was able to establish within a few minutes that there were around 50 similar vehicles being sold currently, all but a few of which were clustered in a tight price band. This provides a perfect enough market for price & value to reach the same point.

Similarly, in the residential real estate world, many market appraisals use search engines which can quickly and accurately show comparable product and recent sales history, again allowing market mechanics to establish value.

There are a number of very important differences in the area of business sales:

1.    Business investment is made in order to generate a return over time
2.    There is less uniformity in product
3.    Data is far less easy to come by, and in many cases may not exist
4.    Markets are imperfect

It is this last difference which I will discuss.

Using NZ as an example market, we regularly find that a business we are appraising has significant differences to other businesses in the marketplace. It is often not possible to find even a single close enough match to be genuinely instructive. We also regularly find that the market into which the business is being sold is very thin.

Thus, in the absence of sufficient comparable product to establish a proper market place, and the absence of sufficient buyer base to establish competition, we find that many businesses do not meet the IVSC definition for readily establishing market value from market evidence.

It then follows that it is critically important to go back to first principles of valuation from an investor’s viewpoint – that is, ROI given appropriate consideration of risk.

Where the business in question is a small, relatively vanilla type of business, we certainly do find that market data and available comparable product can readily establish value within a low tolerance of error.  

Many businesses I appraise do not fall into this category. Consequently, a deep understanding of the various techniques for valuing businesses from a theoretical basis is essential.

Once value is established, the broker must then ensure that the business owner understands how business value has been determined, and equally importantly, understands that this value will not necessarily equal price in an imperfect market. I would then argue that once sold, if the sale has taken place where there is one such business in existence & for sale, and has a single buyer or small handful of interested parties, then whilst the ultimate sale price is interesting, it is not necessarily more than that.

CPE – The more the merrier!

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