Don’t drop the anchor. Avoiding bias in business valuations
17 May 2016
It’s a cliché that business valuation is both and art and a science. Or as it’s been more aptly put it is a craft. Either way it needs to be done thoughtfully. You don’t need to look hard online to find sites that invite you to put your data in and I’ll value your company for a low fixed fee. Trouble is that “under the bonnet” this is just some maths – this is a problem because you have no idea if the site is asking the right questions, and more importantly its only as good as the data input. As they say garbage in garbage out.
But if you do treat valuation as a craft, to be conducted thoughtfully, making insightful and supportable judgements about the business at each step you need to guard against bias – and this can arise accidentally.
Anchoring is a well documented phenomenon. There have been psychology experiments that have demonstrated this. Business students are asked if they’d pay the last two digits of their national insurance number for each of several items. Then they’re asked the maximum they’d be prepared to pay item by item. Despite it being random students with higher NI numbers consistently indicated higher maximum bids. The anchoring phenomenon can work to ones advantage – it’s a reason why it’s often helpful to go first in a negotiation – to try to anchor the debate at your end of the value range. But it has no place in valuation as the valuer should form an independent judgement.
So as a corporate finance adviser I’m keen to understand what my clients objectives are as input to negotiations. Conversely as a business valuer I need to be deaf to the client’s desired valuation. This might be a business valuation for divorce purposes, or to do with shareholder exit, or tax. But I need to avoid anchoring bias to make sure I arrive independently at my best judgement of valuation which is supported by the evidence and by my understanding of the business.
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