The Endowment Effect When You Sell Equipment or the Business

Why this matters

Owners routinely turn down fair offers for things they would never pay that price to buy. A used truck sits on the lot for four months because the owner "knows what it's worth." A jetter used nine times last year stays in the shop because selling it at the going rate feels like being robbed. And at the biggest scale, an owner who has spent twenty years building a business sets an asking price no buyer will meet, waits, and sells three years later for less, or closes. The gap is predictable and has a name. Knowing it does not make it go away, but it gives you a way to look at your own price from the buyer's side of the table before the market does it for you.

The idea

In a well-known 1990 experiment, Daniel Kahneman, Jack Knetsch and Richard Thaler gave coffee mugs to half the students in a class and let them trade with the other half. Owners and non-owners should have valued identical mugs about the same. They did not: people who had been handed a mug asked roughly twice what people without one were willing to pay. Few mugs changed hands. Thaler called this the endowment effect: people value something more simply because it is theirs.

Two terms make the gap precise. Willingness to accept (WTA) is the lowest price an owner would take to give something up. Willingness to pay (WTP) is the highest price a non-owner would pay to get it. For the same item, WTA consistently sits above WTP. Part of the explanation is loss aversion, the tendency to feel a loss more strongly than an equal gain (see related: Loss Aversion and Why Owners Will Not Raise Prices). Selling registers as losing the thing; the money coming in registers as a gain, and gains weigh less.

In a shop the effect gets two boosts the mug experiment did not have:

• Effort. People value what they built or fixed up themselves above what they bought. The truck you rebuilt the lift gate on, the van you racked out over two weekends, the customer list you earned call by call.
• Identity. A business is not just an asset to its founder. It is years of their life, the reason their name is on the trucks, and often their social standing in the trade. A buyer is purchasing a cash flow. Those are different objects with the same name.

What the seller sees and what the buyer sees

The same asset, described from each chair:

The buyer's column is not cynicism. It is the only column that determines a price, because the buyer is the one paying it.

Worked case: selling the business

A residential HVAC business with fourteen people. The owner, 61, founded it 23 years ago. She has a figure in mind: about five times the business's annual seller's discretionary earnings (SDE), a common small-business measure meaning profit before the owner's own salary and benefits, interest, depreciation and one-off expenses. Five times sounded right because a friend sold a larger business for about that, and because of what the business means to her.

Her broker brings two serious buyers. Both offers come in near 2.5 times SDE, with part of the price paid only if revenue holds for two years after the sale (an earnout). She is insulted, and nearly ends the process.

A buyer's analyst writes notes like these during diligence:

DILIGENCE NOTES - PAGE 2
Owner sells ~60% of replacements herself.
Owner prices all commercial work. No price book.
Top 20 accounts = ~35% of revenue; owner is the
  relationship on 17 of them.
Maint. agreements: ~18% of revenue, 81% renewal.
Two lead techs; one is 63.
Fleet: 6 of 9 vans over 150k miles.
Risk: revenue walks out with the owner.

Every line of that is something the owner could have read about her own business in an afternoon, and none of it appears in her version of the story. Read it as the buyer does:

• Owner dependence. If she personally sells 60% of replacements and holds 17 of the top 20 relationships, a large share of next year's earnings depends on someone who is leaving. That is what the earnout is for: the buyer is asking her to share the risk her own role created.
• Recurring revenue. Maintenance agreements at about 18% of revenue with 81% renewal are the most transferable thing in the business, because they renew whether or not she is there. A buyer pays more for that slice than for one-off replacement work.
• Deferred capital. Six of nine vans past 150,000 miles means the buyer will spend on trucks in the first two years. That comes out of the price.
• Key-person risk. One of two lead techs is 63. The buyer sees a retirement inside the earnout window.

None of this says the business is worth 2.5 times. Multiples for small service businesses vary widely with size, recurring revenue, region and how much the owner does personally, and a broker or a qualified business valuation is how you find the range for yours. It says the gap between five and 2.5 is mostly explained by things the buyer can see and the owner had stopped looking at.

The chair swap

The most useful single exercise against the endowment effect is to price the asset as if you did not own it. Ask: if a competitor were selling exactly this, with exactly these numbers, what would I pay for it, given what else I could do with the money?

For the van, that means pricing the same year and mileage on the open market, then subtracting what you would spend to make it work for you. For a piece of equipment, it means asking how many days a year you would truly run it, and what renting it for those days would cost. For the business, it means reading the last three years of statements, the customer concentration and the owner's role as if a stranger had handed them to you.

The HVAC owner did a version of this with her accountant. Asked what she would pay for a competitor's business where the founder sold 60% of the work and was retiring, she said "not much up front, and I'd want them to stay a year." That was close to the offers on the table.

Use the gap rather than just shrink it

Seeing your price the way a buyer does is half the work. The other half is changing what the buyer sees, which takes time, so it is worth starting years before a sale:

• Move the relationships. Put a sales manager or senior tech on the top accounts now. Owner dependence is the biggest single discount in most small-business sales.
• Grow the recurring slice. Every point of revenue moved into maintenance agreements is worth more to a buyer than the same point in one-off work.
• Write down what lives in your head. A price book, written procedures and a dispatch system make a business look transferable, because they are.
• Fix or disclose the capital. Replace or document the aging fleet, so it is not a surprise found in diligence.

The HVAC owner took the second-best offer, negotiated a shorter earnout, and stayed a year as a paid transition consultant. She later said the price was less painful once she separated the two things she had been selling: the business, which had a market price, and the 23 years, which did not.

Smaller assets: the idle equipment problem

The same effect keeps equipment in the shop that should be sold. A drain shop owns a trailer-mounted jetter that ran on 9 jobs last year. The owner will not sell below what he thinks it is worth, which is close to what he paid. A buyer, or the market for used units, prices it on its age and hours.

The chair-swap question for idle equipment is: if I did not own this, would I buy it today for the market price, given 9 jobs a year? If renting a unit on those 9 days would cost meaningfully less than the market price plus a year of storage, insurance and maintenance, the honest answer is no, and every month it sits, its market price falls. Selling it is not admitting the purchase was a mistake. That decision was made years ago, and the money is gone either way; see related: Sunk Cost in a Bad Hire, a Bad Truck and a Bad Customer.

When holding out is right

A genuinely thin market. Specialized equipment with few buyers in your region may truly fetch more if you wait for the right buyer or list it more widely. Holding out on that basis is a pricing strategy, not a bias, as long as you can name who the right buyer is.

Information the buyer lacks. If you know something real that raises the value (a signed commercial contract, a lease with years left at a good rate) and the buyer has not priced it, say so and document it. That is not the endowment effect; that is disclosure.

No need to sell. An owner with no pressure to sell can set a high price and wait. The cost is time, and time costs something different at 45 than at 61.

References

• Kahneman, D., Knetsch, J. L. and Thaler, R. H., "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy (1990)
• Thaler, R. H., "Toward a Positive Theory of Consumer Choice," Journal of Economic Behavior and Organization (1980)
• See related: Loss Aversion and Why Owners Will Not Raise Prices
• See related: Sunk Cost in a Bad Hire, a Bad Truck and a Bad Customer
• See related: Status Quo Bias With Software and Suppliers