How to Decode an Acquirer’s Maximum Offer

Imagine walking into a car dealership knowing the lowest price the dealer will accept. That knowledge would give you an unfair advantage in negotiating. Instead, buying a car from a dealer often leaves us wondering if we could have pushed for a better deal.

Now imagine selling your business knowing exactly how far you could push an acquirer. Knowing an acquirer’s upper limit is challenging unless you have a bug planted in their board room. However, suppose your potential acquirer is a publicly-traded company. In that case, there is a way to estimate the upper range of what they will pay to buy your business.

Acquirers (and their boards) like making “accretive” acquisitions. In MBA-speak, an accretive acquisition “increases the acquiring company’s earnings per share.” For example, imagine a public company with a total market capitalization of $800 million. This hypothetical giant generated $80 million in EBITDA last year, so we know the market values the company at 10 times EBITDA ($80 million x 10 = $800 million).

Now let’s imagine our hypothetical giant pays $3 million to acquire a company generating $1 million in profit (3 times EBITDA). The acquiring company then reports the new $1 million in EBITDA on its income statement. The $1 million of profit from their newly acquired company increases the giant company’s value by $10 million because the market is valuing every dollar of EBITDA the giant makes at 10 times. (This assumes that the news of the acquisition didn’t trigger the stock’s downturn.)

The giant is now worth $810,000,000. They paid $3 million to make the acquisition, but they increased their market capitalization (i.e., the value of their business) by a whopping $10 million. The accretive acquisition allowed them to make $7 million out of thin air. ($10 million in increased market capitalization minus the $3 million they paid for the acquisition).

What Does This Mean to You?

Acquirers prefer making accretive acquisitions and loathe to make dilutive ones. Suppose you are negotiating with a publicly-traded giant. In that case, a quick online search will allow you to determine their EBITDA and market capitalization, enabling you to calculate the multiple of EBITDA they’re getting from the public markets. Assume that multiple is the absolute maximum they would pay for your business and know they will try to acquire your company for a much lower multiple to position the acquisition as accretive to their shareholders.

For example, Tony Falkenstein started Just Life Group (NZE: JLG) in 1988 to supply fresh drinking water to homes in New Zealand. Falkenstein took his company public in 2004 with a vision to expand the ways he could help New Zealanders live a healthier lifestyle.

Rather than grow his service offerings organically, Falkenstein pursued an acquisition strategy. He purchased seven companies, including one that installed natural lighting solutions and another that specialized in home ventilation systems.

As he told John Warrillow on a recent episode of Built to Sell Radio, each time he negotiated an acquisition, his bottom line was that the investment had to be accretive. In other words, he had to purchase a business for a multiple lower than his company was trading at on the New Zealand Stock Exchange.

In Summary

Dilutive acquisitions do happen when the acquisition target has the potential to revolutionize the acquirer’s business, but winning board approval is much more complex than an accretive buy.

You’ll never know what an acquirer will pay, but knowing that acquirers want accretive deals will give you a good sense of how far you can push them in a negotiation to buy your business.

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