Valuation Gaps Don't Need to Be Deal-Killers

Posted on: 02/22/18

Written by: PSMJ Resources, Inc.

Topics: Mergers & Acquisitions

Valuation is often the thorniest issue and it is a very rare case when buyer and seller are on the same page right from the start. Instinctively, a buyer is looking to get the most bang for their buck and – also instinctively – a seller is looking to get the most buck for their bang.

First, let’s be clear. There will be situations where no amount of negotiation or creativity will bridge the gap. If the two parties are more than 50% apart on valuation, it is probably the result of seriously misaligned expectations or perceptions. But, before you walk away from the deal, consider these options to get to “yes”:

Get specific. It is a very inefficient and frustrating exercise to just sling numbers back and forth in the hopes that one side will bend sooner or later. A much more effective and efficient process is to dig in to the underlying assumptions that are going into each side’s valuation expectations. Remember, this is very much a forward-looking exercise. Talk specific growth assumptions, projected profits, and the overhead burden/investment that will come from the buyer. What is really driving each side’s valuation? Negotiate that!

Change the terms. Price is one lever to adjust…terms are another. If you can’t get to where you want to be on price, look at some compromise on terms. For example, as a seller, you may be open to a lower valuation with a higher cash component. As a buyer, maybe you are willing to pay a little more if the key principals of the seller are willing to stick around for a while longer. There is much more to this than just the price.

When all else fails, consider an earnout. If you’ve gotten to a manageable 10-20% gap and just can’t budge any further, it might be time to call in the earnout. Now, and only now, is the time to start looking at an earnout as a tool to get both sides to “yes”.

In all of this, remember that not every valuation gap can be managed. If you think there might be misaligned valuation expectations on your next deal, find out early. We wouldn’t suggest that you talk price in the first introductory meeting, but it is a good idea to start setting general expectations by the second or third meeting (e.g. what the buyer has paid on other deals or how the buyer values its own stock).

Need some more ideas for building an acquisition pipeline and get to a winning transaction? Check out our popular two-day A/E/C Mergers and Acquisitions Senior Executive Roundtable designed exclusively for A/E firm leaders!