Price Negotiation - a Rocky Road to Travel
Posted by Tom Gledhill on Mon, Dec 14, 2009 @ 02:48 PM
For every lower middle market M&A negotiation between buyer and seller the perceived value of the company and the ultimate price paid for the company travel a rocky road to deal consummation. In its initial stages value can be pulled out of thin air, especially by the seller. "I know someone who sold his company for $$ and his company is a lot like mine." Or, "companies in my industry are selling for X times revenue". Buyers usually have a more analytical approach although their perception of value can be quite different depending on whether they are a financial buyer or a strategic buyer.
From these initial perceptions, the rocky road may continue to an informal valuation. This can provide an estimate of value by using some, but not all, of the techniques that a professional valuator would use. This is typically performed by an advisor or business intermediary.
Most deals move to a formal valuation of the company prepared by a credentialed business valuation professional. A professional has the intention of providing an independent, objective opinion of value using methods and procedures accepted within the valuation industry.
The seller and the intermediary continue discussions relative to the asking price. This is influenced by the market value determined by the formal and informal valuations; what the seller would like to get; the bottom-line price that the seller would accept; and finally, an asking price that they feel comfortable with.
The buyer, on the other hand, is doing his own analysis. This is usually based on free cash flow or some other earnings metric. The deal then moves further down the road:
The buyer makes an initial offer which may or may not be accepted by the seller
The price is negotiated subject to due diligence.
Due diligence may unearth information that results in an adjusted price
The final transaction price subject to contingencies and earn-outs.
The final transaction price after all contingencies and obligations have been met.
There's usually another party involved in the process - the funding source. Prior to closing, the funding source(s) may evaluate the proposed purchase price package and compare it to their concept of value as part of their evaluation of the risk and funding terms of the financing to be provided.
Smaller transactions (under $1 million) will typically go through an abbreviated version of the process described above. Regardless of the size of the deal, the road to the consummation of the transaction is rarely smooth!