The title is a strong statement. I’m sure your mind is racing right now, thinking of candidates for even more toxic statements. “Toxic”, in this case is, of course, subjective. There’s no cobra venom or turpentine to swallow. However, I’m going to convince you that this phrase does as much damage to your business as such gems as, “We’ve always done it that way”, “that’s not in my job description”, or, “there’s just one last question I need to ask before we complete this interview – are you pregnant?” The hits just keep on comin’.
The aforementioned phrases are exemplary of lousy employees and might even get you sued. They still aren’t as damaging to you as “Value is what someone is willing to pay.” Yet, this phrase is one that I hear over and over again – often uttered by folks I know to otherwise be very intelligent and sophisticated. I nearly have to bite through my tongue to not raise issue so as not to start a fistfight at a Chuck E. Cheese’s.
Here’s the deal – value is not “what someone is willing to pay.” It’s an absurd statement that reflects a fundamental lack of understanding of value – at a minimum, of anything approaching what we might consider “fair” value. I’ll come back to what that statement really means. But first, the legitimate question is, “OK, smarty-pants. You’re so smart, tell me what value really is.” I will dispense with the banal definitions or “standards” of value that govern my profession. They are useful for many purposes, but for you, the reader, they constitute semantic junk.
Value is the price that would most frequently be paid and accepted (you know this is important, because I put this phrase in bold, italic and underlined) for an asset at a given point of time if it were traded a large number (call it 1,000+) times in a short time frame. You’d likely get a bell curve distribution (well, more likely a logarithmic distribution, but I don’t want to get too mathy) of prices. The peak of that bell curve is value.
(No, as a matter of fact, I didn’t go to art school. Whyever do you ask?) Pushing the point more forcefully home – value is the price where the neither the buyer nor the seller gained an objective financial advantage at the expense of the other in the transaction. To the right of the peak, the seller got a good deal, selling more dearly than value. To the left, the buyer got the good deal, buying more cheaply than value. When the tug-of-war between buyer and seller turns out to be a draw, and a transaction takes place, that’s where you find value.
Where does this phrase, “Value is what someone is willing to pay” come from? We hear the phrase all the time, but with just a little thought, the entire concept is easily refuted The buyer is either a) ignorant as to the nature of value, or b) trying to manipulate you into selling (to him/her) at their price. What the phrase implies is, this buyer is right here, and you’re probably not going to do better than the offer this buyer (investor) is proposing, so you might as well take it, because the buyer’s offer, ipso facto, constitutes value. More poignantly, the implication is this particular buyer, and this buyer alone, is going to actually part with his or her money – it’s like a financially-themed version of The Bachelorette.
In a real-world context, let’s say 1,000 Chevy Volts (a marvel of American auto engineering, by the way) with identical features in a confined geography with homogeneous demographics are sold in a 3-month period. Further, let’s say the value of a Chevy Volt is $30,000 (not sticker price – it’s around $35,000). Not every Volt is being sold at $30,000. Some are being sold for $31,000. Others for $26,500. Still others are sold for $29,000. A bunch are sold for $30,000 or very close to that price. In fact, a plurality (or majority) are sold at $30,000. That’s what the value of the Volt is. Some buyers got a good deal and bought for less than value. Others paid more dearly than they might have and the dealers won out. Most markets are not so efficient that everyone buys and receives “fair” or “market” value. If a Volt is with what the “buyer is willing to pay”, how do you reconcile the varying prices actually paid? I’ll save you the Tylenol. You can’t reconcile because the statement is inherently flawed. “Value” is a point in financial space. Value not a range (although professional standards allow value to be expressed as such), and value doesn’t have a split personality.
What makes value so challenging from a conceptual standpoint is that value is almost never observed directly. Although value won’t burn your retinas like looking directly at a solar eclipse will, they are both typically observed indirectly. I suppose that is why the business appraisal profession is held in such relatively low regard (I think we are the guys that lawyers make jokes about.) Unlike in accounting, where numbers can and must be tied out to fact and record, value cannot be completely tied to fact, and therefore, the popular perception of the appraisal industry is that the Ouija board, Magic 8-Balls and Tarot decks are as important tools as calculators, reference materials and Excel in our craft.
But that doesn’t excuse the widespread use of this horrific phrase, “Value is what someone is willing to pay.” Here’s an example I use in classes frequently. Let’s say I have a half bottle of Coke Zero, my beverage of choice. There is only half a bottle remaining because I drank the other half. Now, someone offers me $20 for the remaining half, and I gladly oblige with the sale. Was that half bottle of Coke Zero with my nasty germs in the remaining soda and on the bottleneck “worth” $20? Was the value of the half bottle of Coke Zero $20? You are almost certainly rejecting that assertion in your mind. But wait – someone was willing to pay the $20 for this quantity of potentially contaminated Coke Zero. If value is what “someone is wiling to pay”, then that half bottle of Coke Zero’s value was $20. Of course, rationally, you’re thinking, there’s no way the value was $20. The value should have been zero or pretty close to it. Common business sense inexorably leads us to that conclusion.
Now, we get into the “why”. Why was someone willing to pay $20 for that half bottle of Coke Zero? Perhaps the buyer was very thirsty – hadn’t had a drink in 2 days. Perhaps the buyer was of the believe that this particular half bottle of Coke had some sort of magical properties, to cure illness, or grow a giant beanstalk into the clouds. Perhaps the buyer confused this Coke Zero with some other version that was far more desirable. Maybe the buyer thought Adele had drunk from it and was getting some DNA to clone.
Now, let’s take the other side. Someone comes into my neighborhood in Chamblee looking to purchase a house. They find one for sale and that person offers the owner $100 – and that is the maximum amount the buyer is willing to pay. Not $100K (which would still be laughably low for this neighborhood), but $100. The bill with Ben Franklin on it. If value is, in fact, what someone is willing to pay, that house now has a market value of $100. Again, common sense tells us that the notion is absurd. Such an offer would be immediately rejected, probably with a laugh – yet that is precisely the snake oil into which you buy if you accept that “Value is what someone is willing to pay” as an axiom.
The final stake in the heart of the “buyer willing to pay” argument is this: When was the last time you heard, “Value is what someone is willing to sell for?” Never, right? This isn’t an accident. What makes the discussion so insidious is that you most frequently here the phrase from people who are positioned as experts: the venture capitalist, the private equity buyer, the strategic buyer, the investment banker. Buyers tend to do many more transactions than sellers, so it makes sense that buyers tend to have an elevated level of expertise in the transaction world. But in this case, they are wrong. Not only do you have every right to articulate value, but there’s no such thing as value if you don’t argue your value case.
That doesn’t mean the price you are being offered in a deal is necessarily a bad one, but the way to test that notion is to either attract additional bids or to undertake a formal business valuation process. Only then will you get a sense of where the offer price lies on the price/value continuum.
So, why is the phrase, “Value is what a buyer is willing to pay” so damaging? Because you are being manipulated into potentially selling your business, or your shares in your business more cheaply than their value. That can cost you millions of dollars, and once you sell, you’re generally done.
Value is much more complex than a pithy sound bite, and accepting this “fake news” can cost you dearly. Don’t buy into the lie. Don’t allow someone in a position of so-called expertise push you into the trap. As a seller, you have just as much to say about the value of your business as the buyer. Stand up for your right to value.
What do you think? Have I convinced you, or do you have some arguments to make of your own? Leave a comment and raise your own social media profile as well as mine!