Understanding business valuation comparable and the truths behind the values being compared requires a broad understanding of what ‘value’ means. Unsurprisingly, value takes on different meanings, depending on views and interpretations, the circumstances, as well as the role it is playing in a particular transaction.
For instance, the value can mean different things when buying an asset versus selling it. Human nature causes most people to assign more value to the assets they want to sell. This is what economists term as endowment effect. According to studies, people also tend to assign greater value to something that was earned compared to something that was merely gained. For example, a huge sum of money won in Vegas is often perceived to be of lesser value than the same amount in a person’s IRA, because a lifetime of savings went into the latter. Therefore, price and value—though they may seem to be similar—can only be comparable once actual values and other factors that affect the true worth of an asset are weighed.
Business and real estate appraisers have the difficult job of comparing apples to oranges when trying to determine the value of businesses and assets. This is mainly because many companies can generally be compared with their industry peers when others are so unique that they defy comparison. Professional business and real estate appraisers know very well that market based comparisons only scratch the surface and can, therefore, be quite misleading. Businesses, after all, are unique in their ways and have specific sets of drivers that determine their true value. These drivers may include technology and other intangible assets like business relations, staff skills, relationships with customers, and many other factors that add to a business’ competency. It is for these reasons that no two businesses can ever be the same.
A market comparison is usually based on the assumption that a business in the same industry can be interchangeable. Therefore, knowing the selling price of different companies that are of the same size and are operating within the same industry may lead you to believe that the price is more or less standard among similar size and type of businesses. However, estimating the value of a firm requires a much deeper understanding of the different things that drive its worth. This is where business valuation by professional business and real estate appraisers come to play, enabling a more accurate review of a company’s true value.