"So, what do you think my company is worth?" is a question we have become accustomed to hearing - often in the very first meeting, before even being able to analyze and position the company. M&A firms don't like to be asked this question, because they might not have all the facts yet at the time this topic comes up. Even if they had all the information needed on the seller's company and its market they would not have a crucial piece of information, maybe the most important and decisive one: external information, meaning in-depth information on the buyer’s company.
Confronted with the “what is it worth?” question as part of a typical "beauty contest" (a seller asks three or more M&A firms to give presentations with the intent to award the mandate to sell his company to one contestant) the participating M&A firms respond in different ways: some, the honest and good ones, might say that it is premature to give a reliable answer; others may respond differently and conjure up a number that the seller wants to hear just to win the mandate.
What are the crucial elements of the price-finding process?
An optimal selling price of a company is made up of three key elements: a fair valuation of its inherent value, the determination of its external relative value and a decision as to how the external relative value is being allocated to the buyer versus the seller.
Internal value: this is the obvious one; numerous books have been written about it. As a result I will not touch upon it in this article. Suffice it to say that some form of discounted cash flow calculation (DCF) has come to be accepted as the prevailing method of valuation. In this model discount rates and the period under consideration typically are a function of risk and opportunity. The ubiquitous formula (EBITDA x a multiple) is a reflection, a synthesis of the DCF model.
External relative value: this is the added value a company can have as result of synergies. It is relative as different buyers are likely to have different levels of synergies. The most important synergy items are cost, sales and product/technology synergies. Cost synergies (savings) include joint purchasing activities, streamlining of manufacturing, combining of sales offices etc. Sales synergies (opportunities) can be even more significant than cost synergies and include opportunities such as immediate access to new markets/customers/countries or higher pricing flexibility as a result of an enhanced image/perception.
How does a seller know the extent of the potential synergies relative to each of the bidders? He can’t unless he understands the business of each of the competing suitors.
Allocation of synergies: worse, even if a seller knew that the synergies are sizable the potential buyer(s) would obfuscate the issue and claim that the synergies should be his/theirs as without him/them there would not be any synergies. Thus, in many cases, a typical sales process is lopsided, asymmetrical in that the buyer gains more knowledge of the seller's company and its synergy potential than the seller would ever learn about the buyer's company.
How to fill in the knowledge gap?
An auction-style sales process that typically ends with two or three bidders competing for the seller's company can amend the lopsidedness to some degree, but it cannot fully correct it nor can it put buyer and seller on an equal footing unless the seller draws on some additional knowledge and insight that often is provided by or in cooperation with a specialist M&A firm.
Example: a company has revenues of 100 units (U) and an EBITDA of 15 U. Let's assume the typical EBITDA multiple for a company in a specific industry is 7. The price would be 105 U. We have seen many merger situations where a synergy-induced doubling (or more) of the EBITDA (after some time) is common. So, let's assume the synergies amount to another 15 U. So the total value of this transaction would no longer be 105 U. but 210 U.
Who gets to keep this additional value of 105 U? The buyer or the seller? Synergies by definition come from more than one source - in our model from the buyer and the seller. As a result it is a generally accepted practice that the synergies ought to be shared between both buyer and seller. Instead of 105 U. the seller should get a price between 105 U and 210 U. But how much exactly? Where do you draw the line? An auction-type sales process may filter out the highest bidder, but it does not guarantee that the finalist is willing to share its synergies equally and fairly with the seller.
Example: let's assume that - as a result of the auction process - the EBITDA multiple is getting raised to a lofty 8 or 8.5 bringing the price up to 120 u or 127.5 U. However, an equal and fair allocation of the synergies might have given the seller 40% -50% of the synergies amounting to 42 U. to 52.5 U or a total price of 147 U. to 157.5 U (corresponding to multiples in the neighborhood of 10. The seller misses out on a substantial portion of the attainable transaction price as a result of incomplete information on the buyer!
To address his information gap the seller has to make appropriate plans right at the beginning of the sales process:
- pick the right M&A advisors who know the industry, products, markets
- take time; work with the advisors to collect as much information on the buyer as possible; visit the buyer’s company; try to fully understand what the buyer needs
In conclusion, following is a brief check-list of the profile of the ideal M&A advisors for your sales process:
- they should be able to run a good and efficient sales auction process (as any advisor should be able to do)
- they should have a thorough understanding of the industry
- they should have an understanding or being able to acquire an understanding of the two or three finalists in the process, their position in the market, their needs etc. (visiting the buyers’ sites jointly with seller would be important)
- they should be able to understand the psychological mindset of those companies and their decision-makers