When a company merges with or is taken over by another, the shareholders of that company have certain intrinsic rights, one of which is that their shares are purchased at a fair value.
Naturally, both sides will have different opinions about the value of the company in question, with the seller always having in mind a much higher value than the buyer. Fortunately, there are many legitimate ways to determine the true value of a target company, but before we look at those more closely, it’s useful to first clearly define what we mean when we talk about a merger or acquisition.
What Is A Merger And An Acquisition?
Mergers and acquisitions are the areas of corporate management, finances and strategy that deals with the buying or joining/taking over of another company. In a merger, two companies join together and form a new company, which usually then takes on a completely new name and company identity. Often, the two companies involved in a merger are of similar size, in which case we talk about a “merger of equals.”
In an acquisition, a (usually) smaller business is bought by a bigger company is and either wholly absorbed into that company or run as a subsidiary. Companies earmarked for merging or acquiring are often referred to as target companies.
Determining The Value Of A Target Company
Because the two companies involved both have vested interests in the determination of the value of the target company, it is best to employ a professional valuer to make the final assessment. In this way, both sides can be assured of a fair and objective determination.
There are several methods a professional valuer can use to assess the value of a company, including:
Discounted Cash Flow – this is one of the key ways in which a company can be valued, and involves determining present value according to its estimated future cash flows. These forecasted cash flows are then discounted to a present value using the company’s weighted average costs of capital.
Comparative Ratios – there are two main comparative metrics on which acquiring companies often base their offers, namely Price Per Earnings Ratio and Enterprise Value To Sales Ratio. Using the first metric, acquiring companies make an offer that is a multiple of the earnings of the target company, whereas, with the second metric, the price to sales ratio of other companies in the industry is taken into account.
Replacement Cost – although not the most common valuation method, acquisitions are sometimes based on the cost of replacing the target company. This is calculated by adding together the value of all its equipment and staff. This is often tricky in situations where it has taken the target company a long time to acquire its property, assemble and develop management staff and purchase all the right equipment.
These are only a few of the ways in which a company’s value, and therefore the value of its shares, can be determined. For a professional and objective assessment, contact Property Partnership, the professional property valuers.