One of the critical factors in achieving a successful outcome in a merger or acquisition (M&A) is determining the valuation of a private company.  Of course, most sellers have in mind a valuation range they would be pleased to receive.  An investment bank providing advice to the seller and managing the process of a successful sale is expected to have insight into the valuation.  This overview focuses on a situation where the seller maintains an unrealistic view of valuation and reviews several factors that could lead to the failure of the process to complete the sale. 

The objective of any M&A process is to successfully complete the sale of the company but to do so an investment bank, in consultation with the seller, needs to optimally value a business.  Valuation of a private company is part art, part science but it must include a holistic understanding of the process, the seller, buyer, industry, and economy.  The seller’s or buyer’s objectives, needs, and expectations are critical factors, but factors of personality and the treatment of the counterparty are critical as well.    A valuation can become the most challenging part of the process because it’s the leading cause of transaction failure; especially, when founders believe their company is a “lotto ticket”.  A seller may have set his expectations too high based on a recent sale in the same industry: “My competitor sold his company for ten times revenues.” Or, “the market is paying over seven times revenues.” Besides multiples of revenue the financial condition of the company, its market share, customer concentration, growth rate and so on.  But besides these metrics there are payment terms and incentives for the seller to stay after the sale, that is an earnout.  The latter could be a significant factor in differentiating the transaction valuation of one company from another. 

The typical goal of a seller in an M&A transaction is to get the highest valuation possible. There’s a temptation to believe your company is a lotto ticket because there’s always a chance, you’ll strike gold. Right? Technically, yes. But that doesn’t mean testing the market by setting your business’s price above what the business is worth is a good strategy. In fact, there are numerous reasons not to test the market this way:

1. The seller won’t get offers (but other businesses might)

Unless the seller is a monopoly setting a high valuation means that other businesses in your industry seem comparatively more attractive. Buyers may be attracted to the less expensive company in a particular industry and may even contact a competitor to make an offer.  Even if the buyer ultimately acquires the company in question the seller increased the risk of a buyer walking away and certainly delayed the closing of a transaction.

2. The Seller loses credibility

Buyers are usually in the same industry, so they understand the dynamics of the industry, why they need to acquire a company, and at what point they need to walk away from the acquisition. When a seller sets the valuation of the company too high not only might the buyer walk away, the seller may have lost credibility and the buyer is wondering whether it wants this person on his team.

3. Some buyers prefer not to play “Let’s Make a Deal”

Some sellers may ask for a high price because they expect to engage in negotiations, but you cannot assume buyers are open to negotiating high valuations down to their targets.  Estimating the breakeven cost and time for the buyer to build instead of buying is critical.  In addition, the seller may bring along key customers which may be valuable in convincing new customers to complete the acquisition.

4. Beware the overly optimistic Investment Banker (or Broker)

Having an intermediary like an investment banker or broker inflate the valuation to land your business is dangerous to the objective of getting a transaction closed.  Overly optimistic intermediaries that promise very high valuations become a nightmare for the seller.  This becomes a waste of time and resources.    Commission levels that aren’t reflective of the work to be done or the experience of the intermediary is also a negative sign.    These brokers may agree to any price you want just to get you to sign up with them, only to beat you up on price later. Alternatively, they take you as a customer only to hold you as a customer never soliciting you in the market.

5. It costs the buyer money to walk away from an acquisition.

Buyers are not only paying to acquire a company, but they also must bear the cost of lawyers and consultants as well as the cost of any employee, who is dedicated to the acquisition of a company. Hesitation, also means that you are not serious about selling your company and wasting everyone’s time.

6. Beware of Deal Fatigue

Deal fatigue is real; and it is a condition during the negotiation where parties on either side begin to feel emotional exhaustion during the transaction of the seamless never-ending deal process, counters, hesitation, and negotiation. Deal fatigue can cause the buyer or seller to stop engaging in meaningful conversations due to feelings of frustration, irritation, and continued expense, creating new barriers for the deal and exacerbating ones that might already exist.

7. Outside Capital Constraints

Chatsworth Securities has been in situations where the buyer requires capital to finalize the acquisition of the company, and usually this can come from a lender. The lender will also need to review the business valuation. When the valuation does not support the sales price, then your buyer won’t get the loan. If you’re set on a higher price, consider making improvements that add to the bottom line and of course, add worth.

8. Poor Integration Process

A major challenge for any M&A deal is the post-merger integration. A careful process can help to identify key employees, crucial projects and products, sensitive processes, matters impacting bottlenecks, etc. Using these identified critical areas, efficient processes for clear integration should be designed, aided by consulting, automation, or even outsourcing options being fully explored.

Chatsworth Securities has a long track record in selling business.  Meeting with a Chatsworth Securities advisor will be very helpful in determining the value and sale price of your business. Selling a company is the goal when engaging an M&A advisor, and the expectations should be set at the start of the exit process. Sellers should approach the sale of their business with a fair understanding of the business’s past successes and failures and reasonable expectations about the price and future growth post-acquisition. The more you prepare yourself with facts, the more success you’ll have when you sell your business. Be realistic when you are selling your business and do your homework with a capable advisor before you go to market.