Thinking about using stock in your next deal? Don't make a million-dollar stock mistake!
The use of stock as a form of currency in a merger or acquisition is nothing new. In addition to cold hard cash, promissory notes, and maybe an earnout or external financing, there are many buyers will use stock as some element of the deal.
In addition to preserving precious cash, getting stock in the hands of a seller can be a valuable tool to keep them motivated and driven to create value. In some respects, if you’ve been turned off by the complexity and counterintuitive nature of earnouts, stock can be a great alternative “carrot.”
Despite the significant benefits, there is one significant snag with buyer stock as a transaction currency. That is, it assumes the buyer’s stock is valued at fair market value (or something close to it). Too high and it will likely trigger push-back from the seller; too low and you’ll be handing over more (maybe a lot more) stock that you need to. The ‘too high’ scenario doesn’t come up all that often in A/E deals, but the ‘too low’ scenario comes up quite often. In particular, this comes up when a buyer values their stock at book value.
Book value (simply assets minus liabilities on the balance sheet) is a simple value to calculate, it will generally hold pretty stable over time, and it keeps stock relatively affordable. That is all good, but the big trouble with book value is that is generally a quite conservative (read “low”) valuation method…the typical A/E firm has a whole lot of intangible value that isn’t captured on the balance sheet.
If you are valuing stock using book value, and see potential acquisitions on the horizon (or even if they aren’t visible on the horizon just yet) no need to panic here. There are ways to take action and get your valuation method in alignment with the firm’s fair market value without upsetting the apple cart too much.
For starters, you could consider a phased approach that gradually transitions the stock valuation method over a period of time. The result is a managed process that doesn’t wreak havoc for buyers or sellers within the organization.
Whatever strategy you choose for moving away from book value, the first step is a valuation from a qualified business appraiser to understand what the firm is worth today. From there, assess your options and take action! The financial flexibility of stock in a transaction will open up a new world of possibilities when it comes to structuring a winning deal.
This article is featured in PSMJ's M&A Insider - Volume 8, Issue 10, which also provides a full list of recent M&A transactions as well as spotlights current M&A opportunities.
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