Fair Price Versus Affordability
Most large strategic buyers have well-developed organizations and practices related to acquisition finance and valuation. Theyre experts at determining the fair value of potential targets using traditional methodologies such as discounted cash flow analysis, comparable company and/or transaction analysis, and asset-based valuation.
When a companys value is difficult to determine because of its size or lack of profitability, these companies seek to understand the capital structure of a company and the different levels of financing that its received to determine the price at which investors might have an interest in selling.
Ultimately, though, strategic buyers make decisions about how much they can afford to pay a company largely based on the anticipated performance of the business combination, estimating the Incremental cash flows that arise from increased sales of products and services as well as any anticipated cost savings due to the combination. Presenting the sellers view of both during the sales process helps establish a more aggressive starting point for the discussion.
While acquiring, company executives tend to approach revenue and cost synergy estimates very conservatively due to the fact that they have the subsequent responsibility to deliver on these. Selling company executives and principals tend to be overly optimistic and discount the fact that any acquisition is accompanied by substantial execution risk.
The Bottom Line
To come to a mutually beneficial outcome, a realistic and constructive conversation around the combined entity value proposition and how to mitigate the risks that will certainly present themselves in the execution is essential. Remember that buyers look at both desirability and affordability to come to a conclusion about whether they should purchase and that it pays to educate them on both fronts.