Why is determining the economic value important? When selling a business, you may think it is ultimately just about the price you are paid or, if you are the buyer, the price you are willing to pay. This may be true, but it is important to have a clear understanding of the difference between value and price first.

The economic value at a given date is the present value of all future cash flows from a valuation object (a business or project). This calculation takes into account elements of time, money and risk. Buyers and sellers have their own (subjective) perspective when considering the business on offer. A different understanding of the strategy to be implemented and market opportunities, but also a different risk profile result in different economic values.

On top of that, prospective buyers also have a “buy or build” option. Instead of buying the business, how much would it cost a buyer to build it themselves? A buyer may have to spend much more or much less money to build their own customer base, develop technology, or position their brand. The time required to get to the same level or size, must also be considered. The consequence of this approach is that the economic value of future cash flows is not necessarily the starting point of negotiations.

What about the price that is paid? The price is the outcome of the negotiations between a voluntary buyer and a voluntary seller, the final stage of the process. It is therefore important to first determine what the economic value of a business is. This will strengthen your negotiating position to realise a good price.