How to determine offer price when buying a company

It can be difficult to determine an offer price when you have targeted a company for purchase. We often get the question, “How much should we offer?”  In order to answer this question, you'll first need to consider:

  • How much return on investment you can expect, given the risks associated with purchasing the targeted company.  If the target company's customers are highly concentrated and the business doesn't have a long track record, the risks are going to be higher.  Likewise, if there are major changes taking place or about to occur in the industry, the risks will be higher.  We see this in our government contracting practice with the proposed sequestration cuts.  If the government cuts back on outsourcing, future revenues could be drastically reduced, depending on when and where the cuts occur.
  • What you would offer if you were looking at this company as a separate investment.  Typically, this figure would be the expected cash flow from the company based on historical financial statements divided by the expected return on investment.  For example, if you believe the company will generate $500k in annual cash flow and you want a 15 percent return, the maximum offer would be $3,333,000 ($500k/0.15).
  • Whether it is a more strategic acquisition and other competitors are bidding.  If this is the case, the analysis becomes more complicated.  Can existing costs be reduced?  Can revenue be increased by selling to the buyer’s existing customers?  Can revenue be increased by selling the buyer’s products to your customers?  Do they have key suppliers you want to access or customers that you want to acquire?  In these situations, it is a question of how much the buyer is willing to pay to the seller for cash flow that is effectively created by the buyer.

In any case, we recommend not starting the process at the highest price you are willing to pay.  If your offer is not enough, the seller will typically come back and give you an idea of what they expect.  Even if they come back with a higher number, there may be other options to still make the deal work (e.g. get seller financing at a reduced interest rate, get the seller to agree that the purchase price is only valid if certain cash flows are obtained, etc.).

What has been your experience with acquisitions?  Is your company contemplating an acquisition?  Share in the comments.

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