The difference between value and price (2023)

We've been hearing a lot lately about the many lengths to which M&A deals take place in our industry. And we often get asked why Truelytics ratings don't reflect the same multiples. In fact, we hear this question so often that we felt it was important to express our thoughts and provide some clarity.

The current M&A environment

First, let's take a look at some of the reasons such high multiple trades happen in our space. There are several factors at play that are driving prices to the exceptional levels we have seen recently. First of all, there is a lack of vendors. I often joke that in a room of 100 consultants, I ask who wants to be a buyer and I raise my hand to 99 people (all 100ΒΊthe adviser fell asleep in the far corner of the room). And we often hear from industry lenders that there are 50 to 100 buyersof the seller. Well, the demand is equal to a profit margin.

Second, we now have easy and affordable access to capital. Unlike 10 years ago, there are numerous lenders in the industry who understand our industry and are willing to lend to borrowers at attractive interest rates and terms (for example, 10-year loan terms are common). Access to capital makes buyers more comfortable with a higher purchase price and uses that leverage to outbid competing buyers. These factors, combined with our current low financing rates (not to mention pandemic-related incentives like six-month payments), have resulted in even higher premiums being charged on purchase prices.

Furthermore, many buyers recognize that they are not just buying a company for what it is today or what it was in the past; You buy the growth potential. For example, by acquiring the business of a former consultant, a buyer may see an opportunity to increase portfolio share of the acquired client base or to attract his/her heirs. In other cases they canacquire your talent orother strategic value.

Finally, and let's be honest, some buyers are inexperienced. Instead of using the desired return on your investment to determine a reasonable purchase price, they simply apply a multiple of what they've heard is a good price, perhaps without fully understanding the mechanics behind it. Others get carried away by the emotion of the purchase and end up paying more. This is usually less common when a deal is financed through a lender (rather than the seller having a note); many offer thissolid advice and information on prices and conditions.

If you come back to a multiple at the end of the day using the purchase price (which often includes a premium) divided by company sales, yes, it's not uncommon to see multiples of 3x or more. But that doesn't mean it's an accurate way to determine a company's value.

(Video) What's the difference between price and value?

Evaluation and approaches

A valuation helps assign a fair value to a company as it is today, based on its performance in recent years and other companies of a similar size. The assessment is a starting point that allows you to move forward with confidence. It is not intended to predict future results beyond what is known about the current business.

But just because the review isn't a crystal ball doesn't mean you should dismiss it. An appraisal is when it is calculated correctly. The assessment not only helps provide a starting point for negotiations, but also provides a deeper insight into the strengths and weaknesses of the deal. and maybe–more important–It is also required if you expect to obtain financing from one of the lenders that serve RIA's independent financial adviser and M&A marketplace.

Commonly used valuation methods can be grouped into one of three general approaches: asset approach, income approach, and market approach.

asset approach

The asset value approach essentially takes the market value of a company's assets and then subtracts the market value of its liabilities. However, identifying a company's assets can be difficult, especially when it comes to off-balance sheet assets, that is, intangible assets.

It goes without saying that companies in our industry are built primarily on 'intangible goodwill' (ie customer relationships) and rarely have responsibilities associated with it. Also, this approach is typically used to value a property or holding company and should not be used for an operating business. Therefore, the asset approach is not an appropriate method for evaluating financial advisory practices.

income approach

There are two widely accepted income-based approaches: the compounded cash flow method and the discounted cash flow method. Both methods are used to value a company based on expected future earnings. Simply put, the earnings approach takes into account a company's historical financials to make future earnings projections.

(Video) What is the Difference between Price and Value

market focus

Finally, the market approach determines a company's value by comparing it to the recent sales price of other companies in the same industry. Price multiples are used to determine a fair selling price for the business by comparing it to the market. As an example, we often see market comparisons used to determine a home's listing price.

Understand mergers and acquisitions in the financial services industry

Here's what's interesting about deals in our industry, but few of them are announced or published. And when they do, it's usually the big deals that grab the headlines (eg Goldman Sachs buying United Capital); The deal for the average consultant is rarely published. Even if they are disclosed, the terms (including price) remain largely unknown. This makes it almost impossible for the market approach to be a reliable way to value a company; There simply isn't enough data to make an accurate or fair comparison.

It is now well known that in our industry there are companies that act as "business brokers" who maintain a database of recent transactions that they have brokered. When you consider that many of these brokers do not represent either side of the transaction (or both in some cases) and are compensated based on the closing of the deal AND the value of that sale, you may wonder about the validity of these two dates. . With this in mind, it is logical to conclude that this could lead to a potential conflict of interest: are the asking prices being increased to benefit the broker? We do not claim that this practice exists in our industry, but it is a reasonable consideration to take into account.

Muere Truelytics-Rezension

With only two viable assessment approaches for our industry, you may be wondering how Truelytics performs assessments.

The Truelytics platform is based solely on the income approach and specifically the Discounted Cash Flow (DCF) method, which is used to estimate the value of an investment based on its expected future cash flows. In other words, our DCF analysis attempts to determine a company's current value based on projections of how much profit the company will make in the future.

Remember that you cannot combine scoring methods within methods; you must use one or the other (or average two or more methods). Therefore, it is important to remember the revenue approachNOconsider or consider market comparisons; they are different methods. The earnings approach considers a company's future earnings potential based ONLY on that company's past (and projected) performance.

(Video) Differences between Price, Cost and Value.

It can be helpful to think of the earnings approach as a measure of intrinsic or underlying value and the market approach as one that reflects demand in the market and what someone is willing to pay based on current conditions.

Market Comparables

I think it makes sense to transfer the concept of market focus to the real estate market. When home demand is high and mortgage rates are attractive, we tend to see home prices rise. Similarly, when the market slows down, real estate prices fall; Think about the difference between the real estate market of 2008/2009 and today.

Keep in mind, however, that the underlying value of the home doesn't actually change (at least in the short term). The county tax assessment would also not immediately change for this property based on a recent sale price.

Also, look at the value from the lender's perspective. Let's say I put my house up for sale for $350,000 and I have multiple bidders who have entered into a bidding war. BecausedemandI received and accepted an offer of $400,000 for my house. Of course, my buyer needs credit, so the mortgage company sends an appraiser to appraise my property. But this appraiser examines and analyzes the value of my home, separate and apart from the purchase price and market prices. It is not uncommon for purchase prices in a 'rising' real estate market to far exceed the actual value of the property as determined by the lender/appraiser.

When it comes to real estate, it's easy to determine the number of bedrooms and bathrooms and the square footage of a home. This is not the case when analyzing companies; often the measure of value used may not be clear, as may the details of the companies being sold. This further complicates the validity of the use of market compositions.

"I'm unique"

This is perhaps one of the phrases that entrepreneurs hear most frequently today. Every company, every consultant, believes that it is different from the crowd; that they are unique. If this is indeed the case, why would anyone want to use market comparisons for evaluation?

Even with typical manufacturing companies, the company in question should differ in some way from comparable companies (size, structure, product diversification, etc.). The differences become even more extreme when looking at service companies and are much harder to pin down.

(Video) Session 16: Value and Price - Discerning the Difference

Value vs. Price

After everything we've covered so far, the big question is: Why do buyers pay such premiums on the income approach assessment to acquire a business?

Often for economic and commercial reasons. Just look at valuations of public companies and how macroeconomics and market forces affect them.

Very few shares are valued at the book value of the underlying company. But understanding the book value of a company is important if you are another company considering buying the company. This is a kind of floor definition for your investment. At least the book value. Then factor other things into the equation such as business growth, industry growth, strategic value, brand value, location value, etc.and then, of course, the other market and economic forces come into play.

Cheap money (low cost of capital or fast growing market) makes it easier to digest or rationalizehigher price to close the deal. Or increased competition may force one buyer to outbid others.

Purchase prices are determined by a variety of forces that are not always strongly tied to valuation, just as stocks are sometimes valued at much higher than the company's underlying book value and rational growth projections.

However, they are difficult to quantify when you look at the composition of the market: you will rarely know the objectives behind the final purchase price of the buyer.

value is what it is

This brings us back to the difference betweencouragemiPreis. Just because something sells for $50,000 doesn't mean it's worth may be worth itespecialbuyer but...

(Video) The Differences Between Costs, Price and Value

Consider I can make a grilled cheese sandwich at home for about $2 if you factor in ingredients, cookware, electricity/gas, etc. Now I can go to the restaurant down the street and order the exact same grilled cheese sandwich, and pay $10 for it. Has the underlying "value" of the sandwich changed? NO. I am willing to pay more for it in the restaurant. It has more "value" to me because I don't have to buy the ingredients, make it myself, or clean up. But if you share the ingredients etc. to make this sandwich, it still costs $2.

And that also applies to company valuations. Market compositions are useful in determining the price.I couldobtained under current market conditions. They reflect what someonemayobe willing to pay. But for the most part, the balance sheet reflects demand, not intrinsic value.


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4. How do I understand the difference between value and price?
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5. CA Swapnil Ghate delivered Lecture on Price Cost and Value
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6. The Difference Between Value and Price; The Labour Theory of Value and Marginalism
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