The price and value conundrum
Monday, October 17, 2011/
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 – something like a newsagency, pharmacy or coffee lounge – then comparisons will be available.
And there are industry models that tend to set 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, then the going can get tougher.
You may decide to head to your accountant and ask them their opinion on the price of the business. Perhaps it’s a valuation that you need.
If you are heading in this direction be careful. 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. And 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 your accountant for a valuation of a prospective business, the real question you may be seeking an answer for 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 a hefty marketing push, then it will not suit you unless you like the marketing part of the business 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 this to both 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 is 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. 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.
Greg Hayes is a director of Hayes Knight and specialises in taxation and business planning advice.
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