Bridging Valuation Gaps in M&A

By Eric Bosveld, Aligned IQ

August 24, 2023

Mergers and Acquisitions (M&A) are often considered as one of the most important corporate strategies to grow a business and create value. The success of any M&A deal, however, depends on both parties agreeing on a fair valuation of the target company.  However, business valuation is subjective and open to interpretation.  Buyers cannot afford to overpay for the business and most sellers cannot afford to leave “money on the table.”

When the valuations of the acquiring company and the target company are different, it creates a valuation gap that needs to be bridged before the deal can be completed. To bridge valuation gaps, both parties need to have a clear understanding of each other’s goals, expectations, and motivations. In this blog article, we discuss some of the most common approaches to bridging a valuation gap in M&A.

1. Negotiations and Facts First: The first step in bridging the valuation gap is to negotiate based on agreed-upon facts and circumstances.  Misunderstandings, misinterpretations, and misinformation can all lead to a valuation gap that can sometimes be resolved through good-intentioned negotiations that may involve discussing and agreeing on the company’s financials, competitive landscape, and future growth prospects.  The future growth prospects need to be realistic and based on a successful track record of entering new markets, acquiring new customers, growing with existing customers and developing new products or services.  We have outlined how sellers should be careful in how they present their projections in a previous blog article.
2. Due Diligence: Conducting thorough due diligence on the target company can help uncover hidden value for the buyer and reduce the valuation gap. This process can help the acquiring company gain a better understanding of the target company’s financials, operations, growth prospects, and risk profile allowing for a reduction in any valuation gap.
3. Alternative Deal Structures: Deal structure can be an important tool to help mitigate valuation gaps. For example, offering earnouts or contingencies, such as a portion of the purchase price being contingent on the target company meeting certain financial targets or other milestones, can help bridge valuation gaps by aligning the interests of the buyer and the seller.  We have outlined many deal structure ideas to consider when there is a valuation gap in a previous blog article.

4. Synergies: Synergies, such as cost savings and revenue enhancements, can also help bridge the valuation gap. The acquiring company can sometimes estimate the potential synergies and use them to help justify a higher valuation of the target company.
5. Third-Party Valuation: In some cases, bringing in a third-party valuator can help bridge the valuation gap. An independent valuation can provide a more objective assessment of the target company’s value, which can be used as a starting point for negotiations.
6. Consider Non-Financial Considerations: Valuation is not just about numbers, and non-financial considerations can play a significant role in bridging valuation gaps. For example, the target company’s culture, reputation, and strategic fit with the buyer can all have an impact on the value of the deal.
7. Communicate Clearly and Openly: Communication is key in bridging valuation gaps. Both parties need to be transparent about their goals, expectations, and motivations. This can help to build trust and avoid misunderstandings, and to find mutually beneficial solutions to any valuation gaps.

In conclusion, bridging the valuation gap in M&A can be challenging, but it is essential to ensure the successful close of a transaction. By considering these approaches, acquiring companies can find a mutually agreed-upon valuation that creates value for both parties.