Dealing with valuation discrepancies in deal negotiations?

During the transaction process, significant differences in asset valuation arise, which can lead to conflicts and protracted negotiations. The use of different valuation methods – discounted cash flows (DCF), comparable companies and deals – often becomes a source of disagreement. It is necessary to consider not only financial indicators, but also strategic aspects such as synergies and market conditions. It is important to involve independent experts in the valuation, which can increase the confidence of the parties. It is also useful to establish preliminary benchmarks for the valuation, which will help to avoid protracted discussions.

Valuations form the basis of PE understanding and assessment of a potential investment. Funds often have a very well set out investment criteria and they know what industry/type and size of investment fits that. Therefore, valuations often act as a first line of defense to filter out the unfit options. A mix of DCF and CCA allows an investor to understand whether a company is on the higher end of valuations or if it is more reasonable. The negatives to CCA and precedent transactions are there is limited available data, especially in Middle Market deals and this often skews the results in one or another direction that could be a “one-off”.

Comparable company analysis may not work in some cases where there is no comparable company or transactions. However DCF is something which fits in all situations and all cases.

Discrepancies regarding the valuation can also be managed by taking into account the distribution of risks. As all private equity transactions need to manage both valuation and price on one side, and the distribution of risks and contingencies on the other side, if there is a gap between the parties regarding the valuation and price, the seller can offer the purchaser to assume more risks or vice versa. This is, more risk assumed by the seller equals more price and less risk assumed by the seller less price, which is regulated with the represnetations and warranties agreed in the sale and purchase agreement.

Managing valuation discrepancies during negotiations is a critical aspect of Private Equity transactions. Often, the seller tends to overstate the valuation based on growth forecasts and optimistic scenarios. Buyers, on the other hand, focus on the risks and unpredictability of the markets. To reduce the gap, it is necessary to use mechanisms such as earn-out, where part of the payment depends on the future financial performance of the company. It is also possible to involve independent experts to conduct an objective valuation or apply models with the condition of adjusting the value based on the achievement of key KPIs. It is important to keep the focus on the strategic value of the asset, and not only on the current financial indicators.

Be proactive and open in your communication. Give a clear explanation of the valuation's justification, and be prepared to share the reasoning behind the figures. This can assist in bridging expectations and averting miscommunications.

Private Equity often uses the support of consultants, industry referrals and technical experts who can help them better understand a company’s strength, risk, or differentiation. In the meantime Private Equity investors also leverage Financial Due Diligence companies that specialize in accounting, audit and financial modeling. Companies like the Big 4 are often a choice. However, the financial modeling and analysis is a crucial part of PE analysts and associates’ assessments and requirements, while the FDD providers could be only seeing the accounting side of things and have no contact with other stakeholders, therefore constraining their critical evaluation.

Make use of seasoned consultants, investment bankers, or financial experts. These professionals can offer objective viewpoints, act as a benchmark against industry norms, and support bargaining to enable both parties come to an agreement on a reasonable price.

Strong-Growth Companies: An earnout might benefit both parties when a business has a strong potential for future growth but its present performance does not support a high valuation. Founders Remaining in Business: Earnouts are frequently utilized in situations when the seller plans to stay on in the business after the transaction, giving them a financial incentive to keep raising performance levels.

Experienced investors often leverage deal and ownership structure creativity which acts as an incentive to previous owners and management to achieve the valuations they aspire to, but with the security that the fundamentals and growth associated with this valuation will be achieved. These are often in the forms of covenants or target based payouts, in the case of roll ups, shares in the TopCo.

Dealing with valuation discrepancies in deal negotiations requires creativity, flexibility, and a strategic approach to reach mutually beneficial outcomes.

Similarly to the point above, the final terms are seen as a way and incentive to keep management and current ownership to keep the business safe and make sensible decisions, which therefore lead to the valuation at the point of sale. This is due to the fact that DCFs are based on growth and efficiency predictions on a future period.

The final terms may address valuation disparities in transaction talks by incorporating the following: Earn-Out Agreements: Base a portion of the payout on results that will be measured in the future. Allow a portion of the payment to be made over time with deferred payments. Offer shares in the purchasing business as equity compensation in lieu of cash.

Seek a Middle Ground I can justify any valuation high or low based on numerous factors so, there is no “absolute” valuation, it’s more of a range. Above or Below the range is not going to be agreeable, but as long as it is within the range, all parties should seek a middle ground. The old adage is that the best deals are where both parties think they got the short end of the stick. If one party feels they “stole it” or they “robbed them” then, it’s not a good deal ??