What Is Your Business Worth? It Depends Who Is Asking?

by Dave Driscoll

The difference in value between a stand-alone sale and a merger can be significant.

A potential buyer recently approached one of our clients regarding a possible merger. We had provided a market-based business valuation for the client within the past few years. The client called with this news to ask whether we would recommend using the previously completed valuation as a basis for opening up a conversation with the suitor. Our response: Absolutely not!

The previous valuation was produced under the assumption that the business was to be sold to a third party intent on operating the business independently. This “stand-alone” value of the business replaces the seller with the buyer, while all other important activities, including employees and expenses of the business, basically remain the same. In that scenario, the seller’s discretionary cash flow of the business is determined and a multiple based on market research and comparable sales data is applied to the cash flow to calculate a market-based value of the business.

That all changes if the buyer is in the same industry and the plan is to merge the seller’s company into the buyer’s. The cash flow calculated for the stand-alone valuation is much more valuable to a “strategic” buyer because of the additional cash flow to be realized by the removal of duplicate operating expenses and efficiencies created through the combined enterprises.

Adjusting the stand-alone value to a strategic value begins with the cash flow identified in the stand-alone valuation. Assumptions must then be made regarding which costs will be removed if the two operations are combined. Most cost reductions may be realized in management, sales and the administrative areas of the seller’s business, but the buyer’s manufacturing/operations can also be impacted through additional capacity, capacity utilization and increased throughput.

The anticipated additional cash flow to be realized through a merger is identified and added to the original stand-alone figure to determine a new strategic cash flow. It’s important to realize that when combining these cash flow values, the buyer will not grant the entire benefit to the seller. The buyer is due its return for undertaking the merger, and therefore the seller should not expect the entire amount to be added to the sale price. However, the seller will realize additional value over a stand-alone value, and the incentive to complete the deal may be substantial in a strategic merger.

Many times the multiples paid on a strategic acquisition are not substantially different from those paid on a stand-alone. The increased price paid is due to the strategic value of the combined enterprises.

Many sellers get a real ego boost by comparing the amount paid to the stand-alone value and gloating about the above-market value paid by the buyer even though it’s actually the higher strategic cash flow responsible rather than a higher multiple. In the mergers and acquisitions world, it’s all about defining the appropriate cash flow for the type of buyer.

Dave Driscoll is president of Metro Business Advisors, a mergers and acquisitions business broker, business valuation and exit/succession planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at DDriscoll@MetroBusinessAdvisors.com or 314-303-5600. For more information, visit www.MetroBusinessAdvisors.com.