Every buyer will have a differing view of what the acquisition target is worth to them. In fact each buyer will have a different emotional threshold as to how badly they want to own the acquisition target. The key to extracting the highest price on the sale of your business is to find the buyer who can afford to and will pay the highest price for the business, in a competitive sale situation.
Transaction Price = Intrinsic Value + Premium Value specific to a buyer (if any).
Intrinsic value represents the underlying economic value of the business on an as-is-where-is basis to a financial buyer. It represents the underlying value of the cash flows to a buyer who will continue the business in its existing state and is unable to generate additional cash flow from it or from a related investment.
Synergistic premiums are paid sometimes by buyers of businesses for valid economic reasons:
- Generate additional cash flow. Creation of growth and strategic advantage not available to either the seller or the buyer on a stand alone basis resulting in expected incremental cash flows over and above what the existing owner can generate from the business. For instance, benefits in marketing such as increased market share, elimination of a competitor, improved distribution can be factors.
- Lower the existing risk profile. Combined size, management depth, customer spread and access to capital can be factors.
- Share the consolidator’s premium. This can arise as a result of, either being part of a larger more diverse business post acquisition, or the buyer’s lower cost of capital.
- Eliminate duplicated costs.
Synergistic premiums are paid when the buyer is prepared to share some of the potential synergies with the seller. Synergies are paid for net of the costs of obtaining the synergies, such as systems integration and termination costs (people, leases).The likelihood and quantum of a synergistic premium being paid increases when:
- Economies of scale are evident in the industry
- The industry is going through a consolidation phase
- The relative and absolute size of the business is important to its competitors
- There is a competitive sale process
Areas where the seller can influence the extent of the synergistic premium paid, include:
- Identification of the most likely buyer
- Ensuring the sale process gets and keeps at the table the greatest number of potential purchasers for the longest time
- Development of scenarios indicating the buyer’s potential returns on equity, by identifying and estimating where synergistic cash flow improvement can be made by the buyer.
- Synergies are easy to guesstimate but very hard to bank.
Value Tip: Do not under-estimate the time and cost involved to bank synergies. In many cases achieving synergies will require significant changes to both the buyer’s and seller’s ways of doing business and we all know how difficult change is to implement.
Non Economic premiums
Premiums can be paid for other less than economic reasons:
- Emotional attachment
- A “must win” the bid attitude
- An arrogant attitude – “we can do it better than the existing management”
Most Likely Buyer
Obviously, for valid economic reasons synergistic buyers can and will pay more for a business than an intrinsic buyer, who buys based on the standalone merits of the business. Therefore when considering an exit from the business, the seller should consider who is the most likely buyer and will that buyer be a synergistic buyer.
The key then is getting the identified most likely buyer to transact. Value tip: As Warren Buffet says: “the search for acquisitions is one continuous baseball game – there will be many pitches, just wait for the right one before you swing.”