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Enterprise Value Calculation: Part II Add-On

Success is the child of audacity. - Benjamin Disraeli

The second part of the formula that is used for valuations of potential synergies for add-on acquisitions is based on identifying for the buyer the synergistic opportunities with the seller, quantifying the amounts over a period of time, qualifying how real they are, and determining a current value that is a fair distribution between the seller and the buyer (taking into account the investment risk the buyer has in making the synergies real). Only the buyer's management sitting with the seller's management can identify these opportunities and place a value on them.

Some areas for discussions cover:

  1. Greater efficiency in personnel.
  2. Reduction of people and overhead because of redundancies
  3. Savings on the factory floor and in distribution with increased volume, better purchasing, and better utilization of assets and resources
  4. Broader and deeper geographical coverage
  5. Better product mix that increases sales and profits to the same customers.
  6. More efficient usage of Research & Development budgets.
Free and fair discussion will ever be found the firmest friend to truth. - G. Campbell

Until these questions are resolved, they provide a "fudge factor" in determining final enterprise value. It is thus difficult to make a determination of final value, unless the findings from Part II are known. However, a synergistic buyer should be prepared to make a handsome offer for the company based on identified synergies, which other buyers, who do not have these synergies, could not match.

Sometimes, if the synergies are questionable, then a buyer will offer the seller an initial cash price based on what they can see and believe in, and then add an earn-out to the price for those synergies that are in dispute. While the initial down payment might be less than what the seller is looking for, the final price once the synergies are obtained can get the seller to a higher price than if the seller was to sell to a buyer without the synergies.

Therefore, it is important for the seller to speak with the buyer in determining the final number.

Exceptional Circumstances

Companies Losing Money

How severely a company is losing money will affect how much the seller will get for the company. Since there are no earnings, the enterprise value of the seller tends to initially focus around book value.

Usually a company that has only one year of breakeven can negotiate a premium to book value, if the problem with earnings is a fluke and is not expected to continue. Assuming the company's fundamentals are sound and the company is returning to immediate profitability, then a combination of book value and an earn-out can be appropriate.

The pursuit of truth shall set you free—even if you never catch up with it. - Clarence Darrow

A company that has been consistently losing money and will probably continue to do so will have possible offers significantly less than book value. The larger the turnaround, the more buyers will be interested. The more assets the company has, the more resources the buyer has to work with to fix problems. Also, the more assets the buyer has, the bigger the payday will be when he makes the fix. A small turnaround will not usually get many buyers' attention, because, even if successful, the rewards are small.

Companies that are Hugely Successful

It is not enough to aim, you must hit. - Italian Proverb

In rare circumstances you will come across companies that are incredibly successful, with rocketing growth and fabulous margins for the foreseeable future. These kinds of companies will command outrageous multiples over a wide range because there is no way to gauge accurately the future successes. These kinds of companies are best brought to large public companies that might be able to gain some synergies, but - more importantly - maintain the perception that they are growth companies. Public companies can use their public stock with high PE's to bridge valuation issues.

However, should an owner want cash and still want to continue to participate with a very meaningful amount of equity in the company's future growth, then a leveraged recap should be of interest. Or, we can further tailor the deal to the company's growth and earnings by giving the owner an earn-out component that can significantly boost the overall price.

Your Next Step

Succeed we must, at all cost—even if it means being a dead millionaire at fifty. - Louis Kronenberger

If you have any questions on the above materials, would like more information about anything you have read about here, or wish to learn how Valufinder may be of assistance to you, please contact us. We would welcome the opportunity to speak with you and to assist you in exploring your options. Please note that all conversations are kept strictly confidential and are without any obligation on your part.