Introduction
I have previously written many articles on valuation of business or shares to assist investors and business executives. In this article I give insights into how a prospective investor or purchaser of a business or shares can negotiate the seller’s asking price down.
How a prospective investor can negotiate business or share price down
In my experience in mergers and acquisitions I have realised that most intended transactions that fail or succeed do so around the purchase price or consideration. An aspiring investor would want to pay the least whereas the prospective seller would want to be paid the most, or a fair price.
The process of coming to an agreed purchase price can be difficult, stressful and at times protracted. In my view the process requires good negotiating skills and deal structuring knowledge especially around finances.
Factors that can influence a price reduction
Below are some of the key factors an aspiring investor can motivate or bring to the table to influence a reduction in the seller’s asking price. They are usually used in combinations.
Do your own valuation
It is advisable to engage an expert business valuer to carry out a valuation of the target business using the different methods and assumptions applicable in the circumstances. Such an exercise normally results in a range of values i.e. minimum to maximum. Obviously as an aspiring purchaser one usually tries to gravitate towards the minimum purchase price.
Understand how the seller valued the business or shares
It is advisable to understand how an aspiring seller has reached at the asking price. The seller may have caused a professional valuation. Understand the valuation method used, the assumptions made, sources and credibility of the data used, the range of values, etc. It gives the purchaser many weak areas to target for negotiating a compromise by the seller.
For example where the Net Assets Method has been used one may target the value of physical assets and completeness of liabilities. For the Net Present Value (NPV) method or Discounted Cashflow Method (DCM) variables such as future sales volumes, selling prices, operating costs, capital expenditure, discount rates such as interest rates or weighted average cost of capital (WACC) may be scrutinised. These have a significant influence of the valuation of the business or shares.
Goodwill
Goodwill is normally spoken about a lot in mergers and acquisitions. Probe its sources, how it was arrived at and if it has not been duplicated in the asking price. It is common to find goodwill added to the net physical assets (physical assets less liabilities). However, the NPV method or DCM is expected to have factored the effect of goodwill or lack thereof usually through sales projections, so goodwill should not be added again.
Payment terms
A prospective purchaser may offer attractive payment terms to induce a lower selling price.
Effect of currency distortions
For exporting businesses valued using the NPV method or DCM test whether fair value will be received for all future export proceeds after the transaction. If not, there may be need for a downward adjustment. Where different currencies are used for valuation check the reasonableness of the assumed exchange rates.
Future funding requirements
It may very well be that a seller is selling because he or she cannot meet the business’ future funding requirements. It advisable to have a good estimate of the funding requirements and use that to negotiate a lower price. The funding requirement might be for working capital or new capital expenditure to replace or expand capacity.
Reason for selling
Understand why an investor is selling and his or her timeframes. An investor in a stressful financial situations where he or she stands to lose more or who has an urgent business opportunity where he or she stands to gain may want to sell quickly and apply the funds elsewhere. Some ruthless prospective purchasers may drag negotiations to make the seller’s situation more desperate such that he or she then agrees to sell at a bargain. This is not different from a python that coils itself around its prey and squeezes it to death.
Contingent liabilities and tax
Always be on the guard for undeclared liabilities or declared contingent liabilities that are not actual yet. It is advisable to have a reasonable estimate and use this to negotiate the purchase price down.
Controlling versus minority shareholding
When buying minority shareholding it is easier to negotiate a lower price.
Likely staff movements
If there will be staff movements after the transactions that will negatively affect the business use that to negotiate the price down as this may result in loss of important institutional knowledge, key customers or suppliers.
New set up versus buying existing business
In some situations it may be cheaper to start a new business though it may take long to establish a market share. Where the price being asked for is too high this factor may be used to argue for a reduction in the purchase price.
Costs of the transaction
A prospective purchaser may negotiate the price down by bringing to the table the costs of transaction such as legal fees, regulatory fees if any, tax, borrowing costs, etc.
Conclusion
Negotiating a purchase price is fundamental in deal structuring and mergers and acquisitions. A serious prospective investor needs very sharp negotiation skills and deep knowledge to negotiate a lower price.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows (GK) Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA (EBS, UK) is a legal practitioner / conveyancer, chartered accountant, corporate rescue practitioner, registered tax accountant, consultant in deal structuring and business valuer. He is also a director with Investacare International (Private) Limited. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
