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In Case You Didn’t Know…Business Valuation Doesn’t Make Titillating Dinner Conversation

November 15th, 2011 by Rebekah Smith

My husband is from a small town, west of Lima.  Like many small towns they have events designed to raise money for the local social and charitable groups (the church, the park, etc.) This weekend we attended an event called “Fall Draw” which is a reverse raffle.  Never heard of the concept? Neither had I, but I quickly found it not only to be a spectacularly fun event, but as the night wore on, I couldn’t help but making analogies to the investing market and business valuations….

The concept of “Fall Draw” is as follows: every couple purchases a ticket and in turn receives a number 1 to 200.  As the night goes on, the MC/auctioneer draw numbers from a hopper (get it, it’s a drawing that happens in the fall?!).  If your number is pulled, you are out.  Finito.  So of course, you don’t want to hear your number called unless it is the last one.

A group of four of us made a decision at the beginning of the night that we would pool our numbers and bingo cards so we were “in it together.”  We also decided to purchase two additional tickets (those who don’t show have their tickets auctioned off at the beginning of the night) so we had four tickets to start the night.  Besides the fun of being in this together, I saw this move as a way to diversify our risk by using the collective buying power of the group.  Much like when you invest smaller amounts with mutual funds.  The collective buying power of the mutual fund allows you more diversification than if you were just purchasing shares on your own.  All of one and one for all!

At any point throughout the night, you could easily calculate your potential return based on the prize winnings and the number of tickets available.  I kept encouraging the people at our table to look at this probability analysis.  I had already calculated that you had to get to a 1 in 25 chance of winning (or a 4% chance * $2,250 of prize money) before you could get over the hurdle rate for the ticket price.  So I went into “Fall Draw” with very set criteria for when we should put our ticket on the “market” (another twist….the event had a self created market.  For every 25 or so numbers called there was an auction where people who still had viable numbers could sell them into the market).  Much like we do in business valuation, I was looking at the potential return on the investment and the risk of being able to achieve that return in determining the appropriate price for selling my interest in the open market.

Now, I doubt many other people were calculating their potential returns at their table as I was (yes, I realize that sitting with paper and my calculator is not normal!). Regardless, very early on, tickets were selling for more than “face value” and far above the potential return.  I was puzzled over why bidders were bidding higher than the suggested risk and return suggested.

Perhaps I was wrong in assuming that the premise of value was fair market value, that of an arm’s length, hypothetical buyer, who was looking at the purchase objectively.  Perhaps these were truly strategic buyers.  Reflecting upon it, the buyers were players already invested in this industry/market and felt that the acquisition of a second ticket at that point in the market (evening) exponentially increased their chances.  Or perhaps it was similar to when an investor owns one-third of the stock and can purchase another third in order to have the majority ownership.  Were these buyers paying a premium above the value for the incremental value specifically to them?

Our friends thought I was crazy when I said I was going to write a blog post on Fall Draw.  I didn’t tell them all the analogies I saw to the market and valuation during the event itself.  As you can imagine, that doesn’t really make for titillating dinner conversation!  But I did have a great time observing the market forces at work….even though I didn’t win any money!

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