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What is my private company worth? Most CEOs and buyers of them don’t know.

by on May 16, 2013
What is the value of your company?

What is the value of your company?

Most CEOs operate their businesses year after year without ever knowing what their company is worth, how much a strategic buyer would pay to acquire it, what factors affect the company’s value, whether they would be better off selling, and if so, how and when?

Senior managers in public companies focus on their stock price, whether they agree with it or not, because it is the daily scorecard of their performance relative to other investment choices.  Private companies, however, lack this market feedback and direction.  Their shareholders and executives rarely understand what their company is worth or clearly see what drives its value.  For this reason, many private companies, and business segments of public companies, lack direction and under-perform.

When buyers see a potential target the valuation analysis is focused on the synergies that can be achieved in a deal.  Typically, the buyer creates all the synergies and theoretically should not pay the seller for the value the buyer creates.  This is the difference between Stand-alone Fair Market Value (“FMV”) and Investment Value.  However if the target is a private company it’s very hard to determine the FMV because there is no daily scorecard, no public stock price.  So in the analysis the buyer may use a number of tools or valuation models to determine a value.  But they’re only as good as the assumptions.  As a result the buyer often times doesn’t know what the target is worth as a stand-alone business, and therefore the buyer does not know what the synergies created by his company are worth, or what the company’s initial offer should be, and often times ends up paying the seller for the synergies the buyer creates.

Sellers are just as uniformed as buyers.  Many times the owners of the targets do not know if they should sell, how to find potential buyers, which buyers can afford to pay the most to acquire them, what they could do to maximize their sale value, or how to go about a sales process.  After all, many sellers are involved in only one such transaction in their career.

Stand-alone Fair Market Value

This value, the worth of what the sellers currently own, reflects the company’s size, access to capital, depth and breadth of products and services, quality of management, market share and customer base, levels of liquidity and financial leverage, and overall profitability and cash flow as a stand-alone business.  This should represent the minimum price a financially motivated seller would accept.

As a buyer, this value should be the base value from which their negotiating position should begin.

I’ll write about how to determine this valuation in a future post.

Investment Value

The maximum value the buyer expects to create from the deal is the excess of the “investment value”, defined as the value to a particular buyer and includes synergies, over the fair market value.  Also known as strategic value, this value is probably different to each potential buyer because of the different synergies that each can create through the acquisition.  The better the fit for the target, the greater the value.

Acquisition Premium

So any premium the buyer pays above the fair market value reduces the buyer’s potential gain because the seller receives this portion of the value created.  Sometimes this difference, this amount, is defined as a “control premium”, but this term is misleading.  Although the typical buyer does acquire control of the target the premium paid is really to achieve the synergies that the combination will create.  Therefore the premium is more accurately referred to as an acquisition premium because the primary force driving it is the synergies, rather than control, which is necessary to implement the synergies.

Negotiations

This leads to two obvious questions:

  1. Why should a buyer pay more than fair market value?
  2. If the buyer must pay an acquisition premium, how much above the fair market value should the buyer pay?

The mean and median acquisition premiums for purchases of public companies in the U.S. over the last 10 years have been about 40% and 30%, respectively.  Premiums paid are based on competitive factors, consolidation trends, economies of scale, and buyer and seller motivations.  For example, a company with a FMV of $10 MM has a much stronger bargaining position if its maximum investment value is $20 MM than it if is $12 MM.  To negotiate the best possible price, the seller should attempt to determine what its maximum investment value is, which potential buyer may have the capacity to pay the most in an acquisition, and what alternatives each buyer has, and then negotiate accordingly.

Buyers should begin their negotiations based on fair market value.  Before they enter the negotiation process, where emotional factors and the desire to “do the deal” take over, buyers should also establish their walk-away price.  The farther the price to do the deal moves above the FMV toward the buyer’s investment value, the less attractive the deal becomes.  Value-oriented buyers recognize that acquisitions at a price close to their investment value require them to fully achieve almost all the forecasted synergies, on time, to achieve the forecasted value.  When a seller demands too high a price, the buyer’s better option is often to walk away and look for one with a better potential to create value.

I’ll write more about negotiation strategy in a future post.

Good company vs. good investment

While a good company may possess many strengths, it will prove to be a bad investment if the price paid is too high.  Alternatively, a company that is struggling may offer a good investment opportunity if the price is adequately low relative to forecasted returns, particularly to the strategic buyer who has the strengths to compensate for the target’s weaknesses, like a stronger sales channel. But that perspective, a good company vs. a good investment, depends on who is making the observation.

p.s.

If you’re wondering how you build a company that you can sell for a premium in a few years, contact me to discuss the Valuation Amplification Process.

I also invite you to download the white paper and learn the 5 step process on How to Quickly Increase Your Valuation: A Proven 5 Step Process.  http://www.therevenuegroup.net/free-offer.html

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From → Strategy, Valuation

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