Businesses often do not sell for their appraised value. This may be surprising for most people outside of business valuation; however, valuators understand that multiple reasons exist that underline why ‘price’ and ‘value’ may differ. Businesses that have gotten to grips with this are better placed when making decisions as to whether they should buy or sell a business.
Price versus Value
Price is specific to individuals in a buy-sell discussion. It is the amount of cash (or cash equivalent) on the table when anything is bought, sold or put up for sale. A sale needs an offer, a party that accepts said offer and the exchange of money (or other means) as a means of securing the offer. Some buyers may be willing to pay more than others, possibly for a strategic or other financial reason, because they can benefit from economies of scale or synergies that are not available to all. The term ‘value’ often refers to ‘fair market value’ during business valuation.
Fair market value is defined as the price, expressed in terms of cash equivalents, at which there is an exchange of property between a buyer and a seller, both of which are acting in an open and unrestricted market and which neither is under any compulsion to buy or sell and when both have reasonable knowledge of any relevant facts.
Fair market value is, broadly speaking, an agreement of what the bulk of potential buyers would agree to pay for an asset, business or business interest.
Realistically, sales may occur at a different price point than the fair market value. This is because the individual parties have their own perception of the risk and return associated with any investment. There are various other reasons, of course, including a lack of relevant knowledge about the transaction or the subject company.
Another reason why value and price may differ is timing. Often, a business valuation is done months or even years before the company is sold. Any differences in, for example, market conditions could cause the company’s selling price to depart from its appraised value.
Price and Value Are Not Synonymous
It is important for both buyers and sellers to understand that, sometimes, the appraised value of a business may not accurately reflect its future selling price. As described above, value can vary substantially depending on the situation at the time of appraisal.
If the reason of a valuation is to establish an asking price, valuators usually give a range of values that considers various scenarios. This range can help a buyer and seller arrive at a reasonable selling price based on the individual expectations of risk and return.
If you are planning to buy or sell a business interest, it is recommended that you contact a business valuation professional for guidance.
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