M and A advisors all over the world on a daily basis field questions on merger and acquisition valuations. Often business owners will point out that they read a comparative business sold for a high multiple and theirs is certainly worth more. Usually, it is the headline “Acme Widget Company sold for $150,000,000″ and all its those zeros that transfix the reader. Although it is plausible the business could have comparative value there are many factors to consider.
- What method was used to determine the valuation for merger and acquisition purposes?
- How was the deal structured?
- Are there components that are unique to that business such as patents, exclusivity or other high entry barriers that drive valuations above the norm?
The most common form of valuation is the multiples of earnings. But what do people mean when they say earnings? Is that what is left over after an owner collects a huge salary, a modest salary or small to none? Have taxes on this already been paid or is it before taxes? If there is debt on the books, have interest payments been subtracted or not in the stated earnings amount? Have one time CapEx (capital expenditures) been removed from the earnings number? Have the profit and loss statements been “normalized”, “recasted” or “adjusted”? Lastly, in determining value were last year’s financials reviewed or was it the trailing twelve months (TTM) or projected pro forma financials?
Since it is often easier to determine how a deal was structured as opposed to how it was valued, lets go back and take a closer look at the Acme Widget Company’s $150 million transaction. Upon doing so it’s determined the buyer did acquire 100% of the company while assuming $75 million in debt, paying $25 million in cash, issuing $40 million in stock along with the potential to earn another $10 million if performance metrics are met (earn out). While the headline may lead you to believe the Acme owners received $150 million in cash at close, as you can clearly see that was not the case. Also, since this was a stock sale accounts containing liquid funds of $5,000,000 were acquired as well as the account receivables. In other words the owners of this company left $5 million in cash or equivalents in addition to account receivables due, to receive $25 million in cash at close. Lastly, other factors not seen out front and center are the type of corporations involved and how the deal was structured for tax purposes.
Even with using this overly simplified example it should be important to recognize not to judge a deal by its headline. If you have a technology business and would like to receive a free business valuation consultation please do not hesitate to contact us.