It was a Lamborghini, a red one, and it whizzed by me like a rocket. My first thought (after saying "whoa...that's wicked cool") was that I’d never want a car like that and I’m perfectly content with my Honda. (Even as I write this, I am feeling how lame that sounds.)
I’m sure the other driver paid a lot for that car (the low-end model goes for about $200,000+) and that’s perfectly OK with me – to each his/her own. Would I ever pay $200,000 for a car? No way – but clearly somebody did.
Why? Obviously, it’s because the value to ME of driving that car is way less than $200,000. But to Speed Racer over there, the value of owning that car was at least what he paid – or he wouldn’t have done so.
Value is based on what economists call “utility.” Utility can be in the form of something ethereal like “pride of ownership” or the time saved by practically flying in a red Lamborghini to the grocery store as opposed to driving your Honda. There are countless ways we derive utility from what we own, how we spend our time and with whom, and in what we do each day.
I’m asked all the time, “what’s my company worth.” That’s not surprising since it’s basically what I do but, in most cases, there’s way more to the question than that. Maybe the question needs to be posed as:
- What’s my company worth to ME?
- What’s my company worth to the person who wants to buy my company?
- What’s my company worth out there in an assumed marketplace to some yet-to-be-identified “willing buyer?”
These are all very different questions and it’s more than I can answer it in this short amount of time we have together but I’ll give you the basics (I know, you stop reading after about 2 minutes. I get it, it’s cool).
For our purposes, let’s call utility something more concrete like CASH. I’m going to assume we all like cash so let’s use that as our yardstick for measuring utility.
Pretend there’s a bread company called “Betty’s Bread” and Betty is thinking about acquiring another bread company, “Veronica’s Bread.” What should Betty to pay for it? Betty does some research and finds out that several bread companies have changed hands over the past few years and the average price is 1 x last year’s sales (Don't quote me - I’m making up these numbers).
What does Betty already own? Well, there are some ovens and some mixers and a whole lot of flour and some delivery trucks and a really great group of people who work in the company and a bunch of customers who buy Betty’s bread – plus the name “Betty’s Bread”. Veronica’s Bread has all those things too.
So, Betty figures she’ll pay 1 x last year’s revenue and acquire Veronica’s company, right? Well, not so fast.
Maybe Betty should say “why do I care what other people paid for those bread companies? I want to know the value to ME of owning Veronica’s Bread.”
For starters, Betty should think about how much revenue she would derive from acquiring Veronica and that means getting her doughy little paws on Veronica’s customers. Betty also gets Veronica’s ovens and mixers and trucks and flour, and the workforce (maybe) and Betty needs to figure what all those things will contribute to BETTY’S business. So, the exercise becomes valuing the added (i.e., incremental) utility from the acquisition of Veronica’s Bread, specifically to Betty’ Bread.
- Let’s say Betty’s Bread is worth $5 million now and after all her analysis, Betty figures that the combination of Betty’s Bread and Veronica’s Bread would be worth $7 million.
- Betty shouldn’t pay a penny more than $2 million to acquire Veronica.
- Doing so would be paying more for the utility derived from the acquisition and why would she do that?
- Actually, there are lots of deals done for things like revenge, spite, and greed but let’s play nice for this example.
What Betty ends up paying may not be the “going rate” but why should she care? The price paid should reflect the value to HER and not anyone else (if you get nothing else out of this, please remember that)
Think of it this way; the price of a Lamborghini would have to come WAY down for me to buy one. I just wouldn’t derive that much utility from it – and where would I put the groceries?
And now here are some words of wisdom from people who aren’t me:
- “My father told me 'Name your price in the beginning. If it ever gets more expensive than the price you name, get out of there.” – Dave Chappelle
- “Price is what you pay; value is what you get” – Warren Buffett
- “What is a cynic? A man who knows the price of everything and the value of nothing.” – Oscar Wilde
Be good and be well.