As a buyer, using the right valuation approach can be the difference between winning or losing an M&A deal. At Corum we've seen buyers lose out on deals because their valuation model did not fit the seller’s market situation. The primary reasons for this mismatch are as follows:

  • The model does not properly gauge the seller's market
  • The model isn't flexible enough
  • The model does not account for synergies
  • The model does not anticipate that the seller may accept the status quo

Market

Financial buyers and a growing number of strategic buyers use a variety of financial models to arrive at a valuation for a seller's company. These models are based on financial data such as earnings before interest, taxes, depreciation, and amortization (EBITDA), net revenue, and discounted cash flow (DCF). However, financial approaches like these may not properly gauge the selling company's market. For example, a valuation based on EBITDA for a business that is focused on growth, or one based on net revenue when the market is looking at top line, will miss the business's true value. In cases like this you may need a different way of valuating the company if the business is one you really want to buy.

Flexibility

Sometimes the model is not flexible enough to pick up important nuances.  For example, churn ‒ the number of customers or subscribers who stop doing business with a company over a specific period of time ‒ is another metric that is commonly used in valuations. While high churn might reflect negatively on a business and suggest a lower valuation, it actually might be something positive. Imagine that most of the churn in a company’s customers is in a lower revenue segment of the business, leaving the higher dollar, higher retention portion of the business. If the model isn't flexible enough to account for this, the model might undervalue the seller's business and you might lose the deal. But if you apply a more flexible, more granular model, one that can account for nuances like this, you will likely win more deals.

Synergy

A major force in driving M&A deals is synergy, the estimated cost savings or increased revenue that may result from a merger or acquisition. Ideally, that synergy results in a merged value of the two companies that is greater than the sum of the two companies' pre-merger values. It's a case of 1+1=3. But if your model doesn't properly account for synergy, you will miscalculate the actual value the seller's company and may find yourself in a weakened position in terms of making the deal.

Status quo

Another factor that causes a mismatch between the model and the market is the possibility that the seller will wait and sell at a later time. We call this situation “status quo”. This is particularly the case when the seller is comfortably pulling out a six or seven digit income every year from the business. Unless the model generates a high enough valuation to entice a sale, the seller may decide to wait. In fact, Corum provides a hiatus program that allows clients to leave the M&A market and then return at a later time when market conditions are more favorable. Significantly, the seller is not billed during this period, and perhaps more importantly, Corum still keeps the client top of mind in responses to inquiries from potential buyers. In other words, Corum will contact the client if there are inquiries from interested buyers during the hiatus period. Buyers can lose out if their model does not generate a valuation high enough that encourages the seller to sell.

Often times a buyer will also wait, hoping that the seller will eventually have to sell. But waiting can be risky. The condition of having to sell might mean the value of the company dropped to a point where the model no longer supports the deal.

Bridge the gap

Ensuring that your valuation model accurately factors in the seller's market can be the difference between winning and losing a deal. If you find a mismatch between your model and the market, try to be creative and flexible in filling that gap. You don’t want to regret losing out on a deal because you failed to take the right valuation approach.