How do you value a target company for a merger or acquisition?

1 Why value a target company?

M&A valuation is essential for several reasons. First, it helps you determine whether the deal makes strategic and financial sense for your business. You want to avoid overpaying for a target company that does not fit your vision, goals, and capabilities. Second, it helps you negotiate the terms and structure of the deal with the target company and other stakeholders. You want to present a fair and credible offer that reflects the target company's strengths, weaknesses, opportunities, and risks. Third, it helps you communicate the rationale and benefits of the deal to your shareholders, employees, customers, and regulators. You want to demonstrate that the deal will enhance your competitive advantage, profitability, and growth.

2 What are the main methods of M&A valuation?

M&A valuation involves three main methods: market-based, income-based, and asset-based. Each has its own advantages and limitations, so it’s best to use a combination of them to get an accurate view of the target company's value. Market-based methods compare the target company to similar companies and use multiples such as price-to-earnings or enterprise value-to-EBITDA to estimate the target company's value. Income-based methods project the future cash flows of the target company and discount them using an appropriate discount rate. Asset-based methods estimate the value of the target company by adding up the values of its individual assets and subtracting its liabilities. Book value and liquidation value are two common asset-based methods that reflect the accounting value or liquidation value of the target company's assets and liabilities.

4 How do you adjust for synergies and premiums in M&A valuation?

Synergies and premiums are two important concepts in M&A valuation that can significantly affect the final price and value of the deal. Synergies are the additional benefits or cost savings that result from combining two companies, which can be divided into revenue synergies and cost synergies. Revenue synergies are the increased revenues from cross-selling, market expansion, product diversification, or pricing power, while cost synergies are the reduced costs from operational efficiency, economies of scale, or resource optimization. Premiums are the extra amounts that buyers are willing to pay above the target company's standalone value to acquire it and can be influenced by factors such as strategic fit, competitive landscape, bargaining power, market sentiment, or deal structure. To estimate both synergies and premiums, you need to identify sources, quantify effects, assess timing and probability of realization, analyze historical premiums paid in similar transactions, consider expected synergies and growth opportunities, evaluate alternatives and risks of the deal, and balance premiums with returns and value creation for your shareholders.

5 How do you test the sensitivity and robustness of M&A valuation?

M&A valuation is not an exact science, but a range of possible values based on different assumptions and scenarios. Consequently, it is important to test the sensitivity and robustness of your valuation results to see how they change with different inputs and outputs. Sensitivity analysis examines how the value of the target company varies with changes in one or more key variables, such as growth rates, discount rates, multiples, or synergies. On the other hand, robustness analysis compares the value of the target company across different methods, approaches, or sources of data. To conduct sensitivity and robustness analysis, you must identify the key drivers and uncertainties that affect your valuation results. This can include internal factors like operating margins or external factors like market conditions. Additionally, you should create different scenarios or cases that reflect different assumptions or outcomes for each key driver or uncertainty. After calculating and comparing the value of the target company under each scenario or case using different methods or sources of data, evaluate the impact and likelihood of each scenario or case on your valuation results with metrics such as standard deviation or confidence interval.