I wanted to post a quick note about the difference between the valuation of a company and the price that you pay to buy that company. This distinction came up after a conversation I had the other day with an associate who had difficulty understanding why he was looking at paying a different amount for a company than the valuation his accountants had given to him.
Valuation and price have different meanings and are (usually) two quite different numbers. A company’s valuation is the financial assessment of a business determined by one or more accepted valuation methods, such as Discounted Cash Flow. Valuation’s main purpose is to figure out a ceiling for what you could pay for the prospect.
The price is the dollar amount that will be negotiated in the acquisition agreement. Remember the core premise that every company is for sale for the right equation. The valuation will certainly form a major part of that equation, but there is no reason to assume it will be all of it.
One of the factors that often must be mitigated is the owner’s ego. For example, your valuation methods may place the value of a company at $35 million, but the owner passionately believes his firm is worth at least $40 million. When constructing your initial offer you may have reason to take into account the owner’s expectation of what he will get for his company.
Other factors that can force a gap between price and value include historic transaction multiples in the industry, revenue replacement issues and even the rumor mill.
I urge you not to throw around the terms price and value synonomously. As you can see, they are quite distinct. A solid understanding of their differences is essential when discussing dollars and cents during negotiations.